Startups can be built in many different ways. From Bootstrapping to Venture Capital there are different options for different types of companies and founding teams. We wanted to review some of the options and the terms that typically accompany them so we can hopefully shine some light on these options.
Bootstrapping is the term used when a founder or founders use either their own capital or profits form the business itself to build and grow. While bootstrapping typically is a slower way to finance the growth of a startup, it is the best way for founders and insiders to maintain 100% ownership of a startup as it scales.
Venture Capital is the most well known and well capitalized form of outside financing for startups. In Venture Capital, fund managers invest capital into startups in return for a % of the business at a set valuation. Typically the venture fund realizes any gains in equity appreciation only during a liquidity event (acquisition, merger or public offering). The one thing founders should be aware of while raising venture capital are the terms that come with it, typically around liquidation priority (who gets paid first) and other terms that typically involve investors having a say in major decisions made by the startup. The big upside to venture capital is that the capital made available is typically the highest multiple of your revenue than other forms of financing (can be 10x your revenue).
Merchant Cash Advances
Merchant cash advances are great for physical goods startups such as DTC consumer brands and or physical subscription products. MCA vendors typically will give you around than 1x your monthly revenue. These capital providers earn their return by charging you a “one-time fee” of around 25% the capital borrowed. Repayment terms are usually 1 year and are tied to forecasted revenue from previous sales or marketing/advertising performance. Obviously merchant cash advances don’t require equity and don’t cause insider dilution.
Term loans are typically 2-4 year repayment terms and have 15-30% interest tied to them. They are structured like a loan from a bank but are provided by institutions that are specialized in providing these loans to startups. The only thing that founders need to be careful of covenants, warrants, and origination/prepayment fee’s which make the capital more expensive to borrow. Term loans can be applied to almost any startup as more traditional debt but it can take longer (months instead of days or weeks) to finalize. Obviously term loans don’t require equity and don’t cause insider dilution.
Revenue Based Financing
These capital providers will usually offer you up to 3x your monthly recurring revenue. They earn their return by then collecting 6-9% of your monthly revenue until they have reached a “repayment cap” which is determined at financing and is usually somewhere between 1.5-3x the amount borrowed. The repayment % each month is typically tied to revenue growth so as you grow you repay the amount borrowed faster. RBF can be utilized for both physical goods as well as digital and software startups with a certain threshold of monthly recurring revenue. Obviously revenue based financing doesn’t require equity and doesn’t cause insider dilution.