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Why is Debt Funding Not Spoken About More in Australian Startups?

Why is Debt Funding Not Spoken About More in Australian Startups?

When it comes to startup funding, debt isn't the first thing that springs to mind - but this is starting to change. Read about debt funding here.

14th February 2020
Reading Time: 3 minutes

When it comes to startup funding, debt isn’t the first thing that springs to mind. From hard-to-get Venture Capital to much sweeter friends & family deals, startup finance is almost synonymous with selling equity. Early-stage companies usually don’t have much more than a highly committed founder, a pitch deck and a dream. Couple that with the fact that your average lender likes to see a little more collateral before he opens his chequebook and you have a good reason why debt isn’t talked about in startup circles.

Australian startups are typical in their attitudes and openness to taking on debt. They are either resistant to the idea or unaware that there are debt instruments that work for early-stage, pre-profit companies. Luckily, things are beginning to change not only globally, but also locally.

The charge is led by established players like NAB, who have supplemented their Venture Debt pool by $2 billion. Though this funding is mostly oriented at scale-ups, this is positive for the entire sector, with many smaller players offering flexible and accessible debt for every stage in a startup’s growth cycle. Lenders have also learned that offering venture debt and early debt can be a great way to capitalise on the growth of innovative sectors without the volatility and risk profile that characterises VC funds. Investors are also happy about the new venture debt boom. This is because it allows companies to extend their runway and solidify their position without having to raise funds constantly and subject earlier investors to dilution.

What types of debt are startups eligible for?

R&D Finance

One of the earliest forms of debt most tech startups can receive is R&D finance. What it amounts to is essentially an advance on the R&D tax incentive payment that a company receives from the ATO. The lender offers this payment early and uses the future inflow of government funding as collateral for the loan. This type of finance can be useful to companies that invest heavily in technology but do not have other types of assets and need time and runway for their go-to-market strategy.

Venture Debt

Venture debt is the most common type of debt that more advanced startups have access to. It is often structured in combination with an equity sale or convertible notes. Often, the companies that access venture debt are already on a growth path and are revenue-generating. Many VCs see this type of finance as extra fuel on the fire of a successful startup. They then use it to balance the growth of the company, their funding contribution, and equity position. In sum: venture debt can be an excellent way to continue to grow if you qualify for it.

P2P Lending

One other source of startup debt funding is P2P lending. Debt crowdfunding or peer-to-peer loans are a new alternative finance option that pools funds from multiple smaller lenders and uses them to creates a loan for an SME. Similar to Venture Debt, this option is open to startups that are already generating a bit of revenue. The upside with debt crowdfunding is that it is often cost-effective. This is because the rates are much lower than other types of debt.

Conclusion

Though it will not overtake equity finance in terms of popularity and sheer glamour in the startup world any time soon, debt funding in Australia is on a growth path with new, innovative forms and much more engagement. As the options expand to include things like R&D finance, venture debt, and debt crowdfunding, Australian startups have even more opportunities to hit the coveted unicorn status.

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Author
Alexandra Kaschuta

Alexandra is a lending and origination manager at Fundsquire, a specialist international lender which helps innovative SMEs obtain funding to grow their business.