How much Debt?
We have discussed a lot of subjects related to a debt raise, but one important issue that we have not yet covered is how to determine the amount of debt that should be raised or avoided.
What are the limitations to debt financing and how far should they be taken?
Do debt raises work in tandem with equity raises?
Well, not to worry as we will cover all of that in this post. Let’s get started.
How much can I raise?
A great place to start is to know how much debt you are actually able to raise. In general, your annual revenue will set the bar for what a debt provider will lend to you. As we’ve discussed, debt lenders focus on the data of your business, and at the end of the day that will determine how much you can possibly get. A lender that sees a trend where you will exceed all of your previous numbers might analyze and decide to lend more than your revenue, but this is not common and shouldn’t be expected.
How much should I raise?
When determining how much debt you should raise, the full amount of capital needed should not be the only factor you’re considering. If your company is already profitable, you should aim to have the smallest repayments possible. Paying 65% of your monthly profits to lenders is not a winning formula. The ideal amount should be less than 40% of your monthly profit, with most industry experts suggesting that you should not exceed 50% of monthly profits. If you are still working towards profitability, you should calculate your debt repayments and the impact it will have on your burn rate. You don’t want 50% of your burn going to debt repayments. In fact, repayments shouldn’t contribute to more than 25% of your burn.
Using debt and equity.
A great way of viewing debt financing is as a stepping stone. While VC will supply larger amounts of capital, debt can be used more frequently. As we discussed before, based on the amount of capital you need, debt might not be the only solution to fill the round.
Breaking your capital raises into separate, smaller, debt raises or even raising a mix of debt and equity, can be a great solution that can be an alternative to a debt-only model. A hybrid model is a great option for many companies as it minimizes your dilution while maximizing the amount of capital you can access.
Debt is a tool.
Equity is a tool.
Different jobs require different tools to maximize efficiency. While debt raises have limitations on the sheer amount of capital you can raise, that doesn't mean debt is the wrong option for you.
Allocating debt financing correctly can be amazing for the long-term health of your company while raising too much can be terribly devastative. Burn rate should always be considered when looking at debt deals and their repayment terms.