Possible Funding Options for Startups: Loans

Startups need money to grow. Therefore, they have to raise funding. The basic financial instruments for startups are the following:

  1. You can sell your shares
  2. You can get a loan
  3. Or you can use convertibles

This film is about getting a loan. Loans are common practice and intuitive to understand. So they should be a sensible option, right?

Erm, wrong. 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 fails. So a lender lends an equal amount to 5 different startups. Then how much interest percentage must a lender receive to break even on their activities? From the lender’s perspective, they should receive at least 25% interest on the 4 startups that survive to recover the cost of the 5th one that failed. Or else they lose money.

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 lender.

It is, nonetheless, quite common for startups to find themselves in debt. It can happen because they fall behind on payments, receive loans in various emergencies, or even because the lender wants to support startups and doesn’t mind that the loan is really not a good investment because it is intended as a subsidy or gift. Sometimes the lenders require that the entrepreneur sign a personal loan guarantee so that their private assets become collateral.

Those loans can often complicate life for startups and their founders, especially when times are bad. When bigger loans come due for repayment, that can be a ‘cause of death’ even when the company is otherwise still promising. Handle with care! Debt is generally not a funding instrument that fits the startup’s life well.

Learn more about loans in our video tutorial:

We hope you have enjoyed our video tutorial. If you have more questions, contact us at info@leapfunder.com.

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