If you are trying to finance a high growth potential business, one important consideration is the balance of risk and reward in your financing path. The tradeoffs are complicated, but neatly summarized in the conceptual graphs above that show the risks and rewards of debt vs. equity.
As an entrepreneur, you sacrifice upside rewards in return for lower downside risks with venture capital. If the business fails, as many do, equity investors will not take your house. Most debt for young companies requires personal guarantees, so there is a big downside if you fail.
Revenue based loans are a niche type of financing that sit somewhere in the middle. They are more expensive than bank loans, but if you succeed you capture more of the upside than with venture capital. But, revenue loans are not widely available, and are really for growth financing rather than startup financing.
Debt vs Equity From the Investors’ Perspective
From an investor’s perspective the risks and rewards are the inverse. Equity investors can lose everything, and often do, when a business totally fails. Bank debt is usually secured by assets, and regular payments are typically higher upfront than for revenue loans. So the downside on bank debt is much lower in the case of business failure.
As you contemplate the graph, remember that our source was a blog post discussing revenue loans or revenue based funding. And of course this is a conceptual graph. Actual risks and rewards will vary based on the specifics of financings. Finally, not all companies have a choice between these three types of financings. The sweet spot would be growing tech companies with over $1 million in annual recurring revenue.
Nonetheless, we found this chart useful. What do you think?