Startups need money to grow, therefore, they have to raise funding. The basic financial instruments for startups are the following:
- You can sell your shares
- You can get a loan
- Or you can use convertibles
Today we’re talking about getting a loan. Loans are easy, right? At least the concept of a loan is easy. Let’s look at an example: Party A, a lender, let’s say a bank, loans the money to party B, let’s say a startup. Usually, the lender lends the money in exchange for compensation. The compensation in general is a percentage interest over the total amount. So in this example, if the bank lends 200K to your startup for 4% interest, then after 1 year, you have to give back 200K (the initial total amount) + 8K (which is the interest). That way the bank gets compensated for the risk in lending you the money.
However, in general, it is very difficult to get a loan as a startup. Why? Well, basically most startups fail. Let’s suppose 1 out of every 5 startups fail. So a bank lends an equal amount to 5 different startups. Then how much interest percentage must a bank receive in order to break even on their activities? From the bank’s perspective, they should receive at least 25% interest to break even on their lending activities to startups. Or else they lose money. This is because the other 4 existing startups should compensate for the loss of one. Now from your perspective, do you as a startup want a loan against a 25% interest? We didn’t think so. And actually, the startup fail ratio is more something like 7 out of 10 or even 9 out of 10. So this is not a realistic business case for a bank.
Learn more about loans in our video tutorial:
We hope you have enjoyed our video tutorial. If you have more questions contact us at firstname.lastname@example.org.
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