Where once venture capital was the accepted and expected pathway for a startup to take, the narrative has started to shift. Venture funding is still celebrated and arguably still ‘the norm’, but there’s a certain acceptance that it’s not the only way.

But, of course, it’s seldom as straightforward as that. There are some businesses for which VC is still the best — sometimes the only — available source of capital.

In this article, we’re unpacking when venture is the right choice, when debt funding might be preferable, and what it all means for women founders.

‍

When is equity the answer?

According to Tractor co-founder, board member and former COO Aprill Enright, equity funding can be the best choice for startups in the early stages that need capital to build, develop and iterate. 

These businesses might still be testing, still working on nailing product-market fit, and not making revenue yet, meaning they likely wouldn’t be able to service or secure debt funding.

Bill Trestrail, startup mentor and advisor, and a board member at SBE Australia, says venture capital is a good option for businesses seeking fast growth, global expansion and ongoing investment throughout.

“Venture capital is the right choice when you can double your valuation every year, and when you want to take money every 12 months,” he says.

“If you want to build your business and sell it in four years, venture capital is not for you. If you want to build a business and grow and scale it at a nice, steady state in a controllable way, venture capital is not for you.

“Venture capital is for when you’re on a growth journey where you need money on a regular basis.”

For Aprill, it comes down to the speed and style of growth a business is looking for. Debt allows entrepreneurs to speed up the activities that will increase revenue. Equity is more suited to long-term investments and scaling fast. The returns will come much later down the track.

“Debt is money for a quick return on investment. It’s not for sinking into long-term development. That should be equity,” she says.

Aprill considers debt to be capital with a purpose. It can feed the “marketing machine,” she says.

“You know that when you put a dollar in the top, four are going to come out of the bottom.”

Investor, founder and startup advisor Noga Edelstein points out there is no shortage of data showing women-led companies are more capital-efficient than those led by men, with some estimates suggesting they generate more than twice as much of a return, per dollar.

“This actually makes them excellent candidates for debt funding,” she says. 

“And, globally, we’re seeing blended finance become a common feature of female funding initiatives.”

‍

Things to think about

That’s not to say it’s always a black-and-white decision. Or an easy one. For some, both debt and equity might be a viable and sensible option. For others, one might be the best route today, while the other might make more sense later on.

Key points to consider include:

‍

Cost

On the face of it, the cost of debt is a financial one — repayment plus interest. The cost of venture funding, of course, is equity in the business.

As Aprill says: “You get this big lump sum of money coming in the door but you’re giving away a chunk of the company, which is giving away your access to a bit of the future capital that your growth is intended to produce. It’s hard to get that back.”

However, most founders we speak to also cite the time cost of raising via venture capital in particular, with Tractor’s own Jodie Imam likening the process to a full-time job in itself. That means turning the focus away from building and growing the startup.

Equity investors also often take a seat on the board, meaning founders also relinquish some leadership control. 

Noga says: “It’s crucial that founders understand the impact of changes to their cap table and board structure, especially at the early stages, when loss of control can have significant consequences.

“For example, the board has the ability to replace the CEO, meaning the founder might find herself out of a job if there are strategic differences of opinion.”

‍

Relationships

This brings us to the key consideration of relationships with backers, whether they’re investors or lenders. VC is a long-term relationship and (while accepting it’s sometimes easier said than done) Aprill advises against rushing into partnerships that don’t feel right, especially out of desperation.

The most successful VC partnerships are built on mutual trust, aligned values and common goals, she says.

And while debt funding is typically a short-term relationship, Aprill still wants Tractor to be seen as a long-term partner that startups can return to for repeat cash injections.

‍

Growth goals

For Bill, it’s key for founders to understand what they want to achieve before they seek funding. 

“What do you want the business to do, and how quickly?” he asks.

If a founder dreams of dominating a global market, and fast, then VC capital will be the way to get there. If they want to be a market leader in Australia, or are hoping to be acquired within five years, it might not be. 

These are all successful outcomes, Bill says. But they require different strategies. 

“Get your playbook, and then get the funder to back your playbook. Not the other way around.”

‍

Support networks

When the relationship is right, equity investors can be invaluable to startup founders in terms of the experience, insights, advice and connections they offer. Again, these relationships are long-term and often personal.

This is another element Aprill and the team wanted to bring into Tractor from day one. In the Tractor Village, relationships are typically less one-on-one, with startups connecting and sharing information and intel through Slack channels and meet-ups.

The Tractor team is also well-connected to the broader ecosystem… including to equity investors.

“We can work with VCs to help founders,” Aprill says.

“There have been occasions where we have helped a struggling founder in our portfolio to get an equity round that has pulled them back off of the brink,” she adds.

“We can give founders that community around them that you don’t get taking debt from somewhere else.”

‍

Mixing and matching

While Tractor’s founders intended to create an alternative source of capital, suited to founders who might not be good candidates for VC, they also intended for it to be compatible with VC — something to support continued growth between venture rounds, or to get a startup into a stronger position to raise with a stronger valuation.

Outside the Tractor universe, however, it’s not always quite as simple as that.

Darcy Naunton, partner at Black Nova Capital and chair of the Tractor board, says once you’re on the equity pathway, switching to debt can be awkward.

“Switching from the venture-funded path onto the debt-funded path can lead your investors to feel you’re lacking ambition,” he explains.

“You could be classed as a failure and get ignored within a venture portfolio.”

Going from the debt pathway to venture, on the other hand, is often seen as a positive.

“It means you’ve scaled up your ambition in terms of your growth rate, and you’re presumably doing that because you’ve found a level of product-market fit that warrants additional investment and more capital faster.”

With that said, he also sees the value in taking debt funding in between rounds. 

Startups have three runways, he says: cash runway, equity runway, and ‘why’ runway.

Cash runway is simply how long a startup has before the bank account runs dry. Equity runway is a little harder to quantify.

“If you give away 20% every round, and do a round every 18 months, you can do the calculations,” he says.

“If the founding team has less than 10% of the ESOP, split three ways, you quickly find yourself in a position where the incentive to build is lower.

“When you can use debt to minimise, or extend the time between rounds, that helps with your equity runway.”

This also relates to the ‘why’ runway, which Darcy describes as the founders’ drive, or “the chip on their shoulder” that keeps them showing up.

“What is it that keeps them busting through walls even on the hardest and darkest of days, when the odds are stacked against you?

“When that runs out you lose motivation and lose focus.”

‍

Bringing the board on board

One of the biggest challenges Tractor has faced is this perception that taking debt after equity is a negative thing. Often, Aprill says, even if a founder is interested in going down the debt route, they struggle to convince their board members and existing backers that it’s a good idea. 

“It’s a mixed bag out there,” she says.

“There is still this hesitation around debt, or a perception that it’s a bad idea. And there’s often a preference by the investor board members to just invest more.

“It’s on us to provide a founder with one-pagers around how to think about debt and use it effectively — and to give them something they can take to the board,” she adds.

“We think about it in the context of what we intend to do with the money — it’s money for a quick return on investment. It’s not for sinking into long-term development, which should be equity.

“But it’s on us to continue educating and providing material there. That’s really where it starts.”

At the end of the day, Noga says, it’s all about optionality. That’s true for women, and for all founders. 

“My advice is to focus on building a sustainable, profitable business so that you’ll be able to choose the right kind of capital to grow your business, without the pressure of a dwindling runway,” she says.