MBA2316 Q&A Wednesday: Should I take on debt financing in my business?

0:09Heyo! Welcome to the$100 MBA show. A better business begins with you. That's why we deliver business lessons for the real world. I'm your host, your coach, your teacher, Omar Zinhome. I'm also the co-founder of Webinar Ninja, an independent software company I started back in 2014. And today's episode is Q &A Wednesday. On Q &A Wednesdays, we answer a question from one of you, one of our listeners. If you've got a question you want to ask, go ahead and email me over at omar at 100mba.net. Today's question is from Charlie, and Charlie asks, Hey Omar, I'm looking to scale my business, and I'm looking for some financing options.

0:41Look at seeking investment from investors, but I'm curious about debt financing. Is this a good option for a software company that's growing slow but steady? Thanks for your help, Charlie. Solid question, Charlie. Debt financing is a relatively new form of finance that has come out. There's some pros and there's some cons that we're going to discuss in today's episode. But in a nutshell, it's a quite sophisticated loan, so to speak. It's not like a traditional loan from the bank. It's sort of like a bank loan mixed with getting investment from an investor. I'll explain in today's episode. But the reason why a lot of people are attracted to debt financing is because there's no dilution.

1:17They don't take a stake in your company. They don't take a percentage or any equity. So for many founders, this is a great first option for raising capital. We'll look into the nitty gritty and what to look out for in today's lesson. So let's get into it. Let's get down to business. Debt financing is very popular in the tech space. In fact, Stripe, the payment processor that's very popular amongst tech companies, has dipped its toe into debt financing as well, offering this service within its service. Right now, I think it's only available in the U.S., but they're expanding in other countries.

1:51But there are other big options, like companies like Lighter Capital, or in Australia, there's Tractor Finance, and others. The way debt financing works is that they see that you have some level of growth. Now, the reason why it's attractive to some founders is you might not have explosive growth, but you have growth. Like, let's say, for example, you're growing 5 % to 10 % month over month, and that's pretty good, especially if you're making less than a million dollars a year. You see, that kind of growth may not be attractive to other forms of investment, like VC firms or angel investors who are looking maybe for more explosive growth.

2:29And that kind of leaves some companies kind of high and dry. Where do I get financing at this point? I'm growing. I want to move faster. I want some capital. So this is where debt financing comes in. There is some growth and debt financing companies will be willing to give you money, depending on how much money you're making right now and how much revenue you're making. They'll be able to give you maybe a quarter of a million, half a million, a million dollars, two million dollars for you to accelerate your growth. So the way it works is that they do not take equity, which is pretty good. So what they do instead is they charge a percentage like a finance fee and take money from your revenue every single month to pay back that money.

3:08Now, obviously, if that big chunk of money that they're giving you accelerates your growth, you're going to be making more money every single month and you'll be able to pay that back faster. That's their hope. Now, and a lot of different companies do this a little differently, but that's essentially how it operates. You take a lump sum, you pay them back every single month automatically through your revenue, through Stripe or your payment processor until the money is paid back. Now, what a lot of debt financing companies does is that they will actually take more money if you're making more money, meaning that you'll pay the debt faster, but it also means if you're making less money, if you're not growing as fast as they expected, they're gonna take away less money so that you're not totally high and dry or can't pay your expenses.

3:53They wanna keep you afloat, of course. Now, what a lot of people do with debt financing is they don't only do it once. Let's say they take on a half a million dollars, that half a million dollars allows them to invest in marketing and sales. That allows them to double their revenue and their growth over a short period of time. This then allows them to dip into another round of funding from debt financing, given the fact that their company just doubled. And some companies do this two or three times. So do I think this is a good option? Well, it all depends on how confident you are that you can grow with the money that they give you.

4:26This is really important. Meaning, do you have a plan in place where you're going to be able to grow your company, whether it's improving your product along with marketing and sales, or maybe you're going to invest in partnerships or whatever it might be. You need to have a plan in place where when you take this money, you're going to make more money. Okay, that's really what you're trying to do here. And that's what they're hoping for. If you do feel confident with that, this is actually a very good option as a first option to seek capital, especially if you have some steady growth in your business, this is going to be a no-brainer for debt financing companies.

4:58They see the promise in your business. They see the track record. They see the numbers moving in the right direction. Some people go into debt financing first, boost their cash, boost their revenue, have their company be in a gray standing. And they have that explosive growth that VCs and other investors are looking for, private equity, angel investors. And they're like, hey, this is a great company and they're in a better position to get a larger valuation and therefore a pretty good sum of money so they can give their company another bigger boost. Now, this is my own explanation, my own personal opinion, but you should advise your financial advisor, your CFO, somebody who knows your numbers before you take any decision.

5:44In business, timing is everything. As soon as you start seeing some growth month over month, this is a good time to seek investment like debt financing. Because you have a good story, you have the numbers to back up your business, and it's the time to grow. It's the time to actually blow up in your marketplace. Now, mind you, debt financing is probably more expensive these days than it used to be because of interest rates. Cash is expensive these days. It's the highest it's been in a long time. Depending on where you are in the world, it could be between 5.5 % to 6%, just the standard interest rate.

6:18So therefore, debt financing is going to be even more because they need to make their money. So you've got to be even more confident that you can use this cash to grow exponentially. If you don't have a solid plan in place where you can double your business, double your revenue in short term, like 12 to 18 months, then reevaluate. Because it is debt after all. now depending on which institution you go for when it comes to debt financing they have different terms different liabilities but the advantage again is they don't take equity but also you're not on the hook like on a bank where you're the grant guarantor where you're liable for that cash the business is liable in the case of debt financing in most cases you need to check the terms but that means if you go out of business they understand that's the risk they're taking You're not liable personally for that financing, for that cash.

7:12Banks, on the other hand, a lot of times they will need you to be a guarantor, meaning that you'd be on the hook for that loan. Now, not all loans are like that. Not all banks are like that. Every part of the world is different. So you need to do your research, again, speak to a financial expert. But usually this is why debt financing is appealing to a lot of people. Lastly, I'm going to give you a reason why you'd want to take on debt financing now and not later. If you're seeing growth in your business and you're in an emerging market where competitors can come around and beat you with venture capital money, with lots of investment, with cash to flood the market and marketing, then you need to act quickly.

7:52You probably are used to just reinvesting in your business by the growth of the money you've made month over month. and you've kind of been running that train and saying, hey, maybe I shouldn't go for that because I'm doing fine right now. But you've got to think a few steps ahead in business. You've got to think the next month, two months, six months, 12 months, two years. Am I setting myself up where I know I can win now and later? And that's why you should be looking at how to finance that growth if you see the heat around the corner when it comes to your competition. Thanks so much for listening to The$100 MBA Show.

8:27and thank you, Charlie, for asking today's question. If you've got a question you want to ask, go ahead and email me over at omar at 100mba.net. I'll make sure to answer right here on Q &A Wednesday. Before I go, I want to leave you with this. Money is oxygen in business. You need cash flow. You need money to grow. You need money to invest. You need money to hire the right people. You need money to market. Without it, it's hard for you to make it happen. And if your business is not making money hand over fist, it's got to come from somewhere. So you need to think a few steps ahead, like I mentioned, but also recognize that even your growth you're having now is not guaranteed.

9:02It may not be sustainable based on your organic ways of growing your business. You might need a boost and manufacture growth through marketing and sales and an engine that you can rely on to bring in new customers every single day. Thanks so much for listening. If you love the show, please leave us a rating and review on your favorite podcast app. It means the world to us. It's one of the best ways to let others know to check out the show. Thanks again, and I'll check you in Friday's episode. I'll see you then. Take care.