- Bank loans are one way founders can finance their business without giving up equity. Due to the high risk associated with financing startups, it is more difficult to obtain funding via a bank loan. However, there are various banks that specialise in offering startups loans. Like with all financing options, bank loans have advantages and disadvantages.
Though prevalent in so many aspects of our lives, a bank loan is usually one of the last options startups consider when fundraising.
This is not surprising as most banks don’t finance startups. This is because from the bank’s perspective, they stand to gain very little from providing loans to startups.
Essentially, the upside for banks who ‘invest’ in startups is the interest paid on the loan. The bank’s return on investment is thus limited to the rate of interest. When coupled with the high risk of providing capital to startups, the provision of a loan is thus an unattractive one. Simply put, the risk to reward ratio is too high.
When it comes to debt financing, banks want a high degree of confidence that the loan will be repaid. As a result, specific business models are more appealing and more likely to receive a loan.
Banks want to see strong evidence for current and future MRR and ARR, contracted future revenue, proof of assets, evidence of future profitability and collateral.
Asset heavy startups are one example of a business model more attractive to banks, particularly in comparison to tech startups. If the startup fails and the bank is looking to take over business operations, this is much simpler to do with assets easier to refinance.
There are some advantages to obtaining capital through a bank loan. For example, bank loans are often appealing to investors looking to provide capital later on down the line. They typically mean the company is less diluted (as the loan was provided in return for interest not equity) and, due to the fact banks aren’t overly keen providing loans to startups, they likely make a startup more attractive to investors as the startup is more likely to be seen as mature and trusted. Moreover, as the loan is provided in return for interest, a company does not have to sacrifice equity and suffer dilution when obtaining capital through a bank loan.
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