While launching and running a business can often feel like an uphill struggle, when the opportunity is there to grow fast, founders need to have the confidence to push hard and take risks.
If capital is the limiting factor to growth, founders should consider debt financing as a solution, says Matt Allen, Co-Founder of Tractor Ventures and Head of Capital & New Markets.
“Founders in Australia and New Zealand often have a negative view of debt, but if you are in the right position you should actually be using debt to accelerate your business,” says Allen. “Don’t use too much, but don’t use none.”
With a background that includes entrepreneurship and mentoring startups (as well as investing), Allen has a strong grasp of the importance of cash flow management for a successful business.
Within the tech space there’s a large amount of variation around realising revenue – whether it’s paid upfront, at the conclusion of a deal, or in the case of most SaaS companies, a subscription model where a company is essentially in deficit for several months until the customer acquisition cost (CAC) has been amortised.
In some cases, businesses struggle to take on or deliver larger-sized deals due to concerns about cash flow.
“The timing of cash flow is as crucial as the deal size,” observes Allen. “That leads to the question, how do you unlock revenue growth when your current balance sheet has real constraints?”
‘Can’t we grow organically?’
Especially for a bootstrapped company with no equity financing, growth will often be slow and steady, with revenue and profit recycled into the growth engine.
That can be the right approach for certain stages of a company’s lifecycle, especially when you’re still figuring out your approach to marketing and advertising, or even if you’re seeing consistent success but still have the odd wobble or down month.
But if you’ve reached the stage where you know what’s working and can see a measurable link between spending on customer acquisition and revenue growth, it may be time to push your foot down on the pedal.
“Once you’ve got to that point where your customer acquisition engine is humming, you’ve got to push through as many dollars as possible to get real growth,” says Allen.
The problem with slow and steady growth is that a window of opportunity may close sooner than you think. An algorithm change by one of the big tech co’s may unravel the effectiveness of your finely tuned advertising campaigns, or a key competitor may unveil a new product that blows you out of the water.
“If clarity around the ability to grow revenue is right in front of you, but you can’t exploit it to the maximum because you feel you can’t invest in your machine to deliver it, that’s when you should look for additional working capital,” says Allen.
Equity vs Debt – which is more expensive?
In markets including the US and Europe, it has become increasingly common for startups to raise a blend of equity and debt.
Here in Australia and New Zealand, Allen believes that there’s less appreciation among founders of the potential of debt financing, and when it can be cheaper than raising equity financing.
He attributes this lack of appreciation to the historical unavailability of debt funding for tech startups, particularly those in their early stages.
As a specialist lender, Tractor Ventures is able to lend to companies with a reliable monthly revenue as low as $50,000. Companies at this revenue stage would typically struggle to obtain a loan from a traditional lender without onerous terms such as a founder’s personal guarantee or putting up their home as collateral.
Given the bias in the tech space for venture capital, many founders might think that selling shares is a better way to fund growth.
Apart from the fact that many companies aren’t a good candidate for landing VC funding, Allen notes that the most expensive time to sell shares is right before your revenue goes up, since equity valuations are calculated in part as a multiple of your revenue.
Equity investors will typically prefer to invest before that expected revenue growth, say if you’re about to bring on a large customer that will double your ARR, whereas it’s in the best interests of founders if they can defer an equity raise until they’ve reached a significant new revenue milestone.
“The challenge for founders is ‘How do we get the revenue where we need it to be without dilution on the wrong side of that transaction’, and that’s where we see debt financing as so effective,” says Allen.
Another important nuance in the tradeoff between equity and debt financing boils down to risk.
If you’re deploying capital into an activity where the likelihood of driving revenue is high, then debt can drive this growth without dilution. If it’s a riskier or more uncertain activity – such as developing a new product or launching in a new market – then equity financing may be the better choice.
“Equity investors may point out that paying down debt rather than reinvesting revenue into growth can have an opportunity cost for businesses,” says Allen. “But the flipside is that selling equity in your company when you’ve got your growth engine humming may come at a much larger cost over the longer term.”
Writer
