Debt financing

Most traditional banks won’t lend to startups. However, every startup still has basic banking needs. Many banks with dedicated technology banking groups are often happy to establish a banking relationship at an early phase. This usually involves open business banking accounts. Founders may also be able to secure a low-limit corporate credit card, sometimes by providing personal guarantees.

Once a startup has either venture capital investment or revenue, some forms of debt financing will likely be available. Depending on the terms, debt financing can be attractive because it doesn’t dilute the ownership of existing stockholders. The most typical form of debt financing is a revolving credit facility provided by a bank to help manage cash flow, with term loans being available for more mature companies. The venture debt space is targeted to venture capital-backed companies, and usually involves a loan with a warrant sweetener.
Loans may be secured or unsecured. A secured loan is backed by assets, which may include the borrower’s hard assets, intellectual property, or accounts receivable. Security may be required by the lender or may be used to drive better terms, such as a lower interest rate.
For early-stage companies, banks may also require a personal guarantee from the founders of the business. It is important for founders to understand what they are signing when they provide a guarantee. Things to keep in mind include:

• Is the guarantee limited or unlimited? If it is an unlimited guarantee, the lending institution may seek recourse for the full amount of the outstanding debt.
• If more than one founder provides a personal guarantee, don’t assume that you are only liable for your share of the debt. The guarantees may be joint and several, which mean that the lender can collect 100 percent of the debt from you, leaving you to collect (if possible) from your co-founder.
• Does the guarantee create a primary or secondary obligation? For a primary obligation, the lending institution is not required to exhaust its remedies against the company—the bank can collect directly from the founder.
• When does interest begin to accrue? In most cases, interest on the guaranteed obligation will begin to accrue from the date of demand.
• What is the interest rate? The interest rate will most often be tied to the interest rate under the initial loan, although the terms of the guarantee will generally prevail.

Questions? Email us at startups@dentons.com.