TRADITIONAL DEBT CAPITAL
When a business is deemed “bankable” – meaning it has a solid credit rating and reliable cash flow – traditional debt financing, such as bank loans, may become a viable option. It generally comes with lower capital costs compared to equity financing in the long run. While most debt financing is arranged through banks, it can also come from private individuals.
From a steward-ownership perspective, debt financing might initially appear to be an ideal option, if accessible. It allows companies to raise capital – sometimes even substantial amounts – without giving up ownership, granting voting rights or dealing with the complexities of designing custom financing structures. By design, debt financing is capped to its repayment amount plus interest, with a clear exit structure. Often standardized contract terms simplify the process, although some negotiation is usually required around aspects like interest rates, collateral, or repayment schedules.
While debt financing seems like a natural fit for steward-ownership, there are still important considerations to keep in mind:
- When banks are restricted from obtaining formal co-determination rights, they may include covenants that, under certain conditions, could grant them the right to claim ownership (equity shares).
- High levels of debt can limit a company’s ability to secure additional loans or government funding in the future.
- Less access to the mentorship that often comes with equity financing. While it is possible to design and build mentorship also into a debt-financing structure if desired, doing so requires an additional effort to create and implement it.
- Banks might need help understanding how debt works alongside other steward-ownership aligned capital (e.g. in the form of mezzanine capital), as traditional banks might struggle to understand the nuances of such arrangements.
Advice: To mitigate potential miscommunications and avoid the risk of loan application rejections, we recommend providing thorough documentation and maintaining transparent communication with banking institutions. Clear documentation that details the structure and intent of steward-ownership-aligned capital might help banks assess the viability and intent of the financing more accurately.
The suitability of this instrument heavily depends on the company’s business model. Companies with predictable cash flows may find debt financing more viable, even in the early stages. However, for most startups, high risk, lack of credit history, and limited collateral make obtaining loans – especially from banks – challenging. Additionally, startups with uncertain or fluctuating revenues often need maximum flexibility to navigate growth and challenges, making the often fixed repayment obligations of debt capital less practical or sustainable. When a company opts for a mix of different financing instruments, traditional debt capital can be part of the strategy. Some financing needs can be covered by equity or equity-like instruments with higher risk, thereby reducing the risk for debt providers and helping secure co-financing from banks. In some cases, debt can even be used to refinance earlier rounds of higher-cost financing, such as equity or mezzanine capital, at a lower cost.
- Interest Rate
- Loan Term
- Repayment Schedule
- Collateral Requirements
- Debt Covenants