5 Ways to Fund Your Business With Debt

So, you’ve got a solid product and traction. Now, you want to take your business to the next level with debt financing.

What’s the best way to fund your business with debt? Banks can be a fine option, and are usually the cheapest sort of debt financing you can find. However, they tend to have a pretty low tolerance for risk, so unless your company has significant revenue (think $5 to $10 million, annually), you’ll need to either borrow based on the value of your company’s tangible assets—or you’re going to need to put your own assets on the line for collateral.

Fortunately, for small businesses looking for debt funding, there are several good options besides a traditional bank loan. Here are five of the most common forms of debt-funding available to small and medium-sized businesses:

1. Online Lenders and Merchant Cash Advances

We don’t recommend using online lenders or merchant cash advances for growth capital, because of their very high cost. However, these alternative forms of debt-funding can be a useful way to get a relatively small loan (under $100K) quickly to weather a cash-flow shortage storm. Due to their high costs, use these sources as a last resort, and double-check the actual cost of borrowing with an effective APR calculator.

2. Revenue-Based Loans

For smaller but solid companies with little collateral, a revenue-based loan can be a good option. Revenue-based loans let you borrow a percentage (often as high as 35%) of your annualized revenue. Revenue-based loans use your revenue not just to calculate how much you can borrow, but also to determine how much you need to pay back each month. That is, your monthly contribution to principal and interest will vary based on your actual revenue. This can be a huge help to companies that have cyclical cash flows, either because they are an earlier-stage company or because there is a seasonal nature to their business.

3. Accounts Receivable (A/R) Factoring

Depending on the nature of your business, some of your customers may pay you upon purchase, while others may pay 30, 60, or 90 days out. A/R Factoring enables you to borrow money based on the money that is owed to you. Your ability to secure a loan depends heavily on the quality of your contracts. If your customers are Fortune 500 companies, you’ll have a good shot at getting this type of loan. If your customers are fledgling startups, not so much.

4. Monthly Recurring Revenue (MRR) Line

An MRR line is a relatively new type of loan where lenders let you borrow three to five times your MRR. These are a quite viable way to fund growth and growth acceleration for your company. SaaS companies with more than $2.5M annualized revenue should check out SaaS Capital, a financial company that provides long-term debt capital to SaaS companies. If you have a tech company with more than $5M in annual revenue, check out a tech bank, such as Silicon Valley Bank. Many have products similar to MRR lines that are designed specifically for tech companies.

Many MMR lines still require a personal guarantee if you can’t secure the loan with your company’s assets, so be sure you understand the risks before you sign on the dotted line.

5. Convertible Notes

For entrepreneurs who are willing to use some equity to attract capital, one way to raise capital from known sources — such as co-founders, board members, and angel investors — is the use of convertible notes, which can offer a flexible and appealing investment structure for both parties. Convertible notes allow founders to borrow money, but hold off on paying back interest and principal until the note comes due. At that point, if the company reaches certain financing milestones, the notes could convert to equity at a discount for investors.

Be careful when designing the terms of convertible notes. Many entrepreneurs inadvertently offer investors multiple liquidation preferences and full-ratchet, anti-dilution rights, both of which can have significant negative impacts on the founder and the company.