tl;dr – Traditional sources of startup funding are drying up due to the fallout from Covid-19. Traditional loans may be an alternative route to pursue during this time. Below are some key sources and terms to learn.
When it comes to funding your startup, there are a few different avenues you can take. As many first time & seasoned founders alike may already have familiarity with, the volatility in the markets and the overall decline of the economy have dramatically changed the fundraising landscape for early stage startups.
Not to mention, angel investors are interested in protecting their company as WELL as their investment portfolios — re, they tend to divert their capital to their companies and are interested in safety rather than yield, and buying bonds over what they perceive to be safer investment assets.
As if founding a startup didn’t already have enough complications — what the above statement REALLY means is that startups have even less capital on the market readily available to them, deals are likely to be smaller and more investor friendly. Alternative financing suddenly becomes a much more attractive option.
Two of the main alternative financing options include traditional and revenue sharing loans. Lendio, BlueVine, FundBox and more (here’s a more detailed list of companies that offer qualifiable startup loans) can help you get the ball rolling. In the meantime, I’ve gathered a list of key terms to help you navigate traditional and revenue sharing loans below.
Key Terms in Traditional Loans
Principal — The principal is the amount a company owes the lender where interest is calculated from. It is normally about the amount of cash proceeds the company receives. However, there may be origination and other fees which would reduce that amount. In short, Principal = Net Cash Proceeds + (Origination and other fees).
Interest — Interest is calculated as a percentage of a loan (or deposit) balance, paid to the lender periodically (or added to a bullet payment at the end) for the privilege of using their money. The amount is usually quoted as an annual rate, but interest can be calculated for periods that are longer or shorter than one year. You can also have simple interest or compounding interest. Without going into the mechanics simple interest would give you a lower amount to repay
Repayment Schedule — Detailed outline of a borrower’s loan agreement with a lender that shows the original loan amount, when payments are due, and how much of the payment goes to the principal and interest repayment. This statement may be provided on a monthly basis or may be issued when the loan is originally acquired.
Maturity — The maturity date is the date on which the principal amount of a note, draft, acceptance bond or other debt instrument becomes due. The maturity date also refers to the termination date (due date) on which an installment loan must be paid back in full.
Secured/Unsecured –– With a secured loan, the lender can take possession of the collateral if you don’t repay the loan as you have agreed. A car loan and mortgage are the most common types of secured loan. An unsecured loan is not protected by any collateral. If you default on the loan, the lender can’t automatically take your property. Since most tech startups don’t have much to secure against (besides code) you don’t see secured notes too often.
Personal Guarantee — A personal guarantee is an unsecured written promise from a business owner and or business executive guaranteeing payment on an equipment lease or loan in the event the business does not pay. However, in the event of non-payment a lender can go after the guarantor’s personal assets. The SBA often requires a personal guarantee with its loans but it has waived that requirement with certain loan types created in response to Covid-19.
Event of Default — This is a defined term you find in your agreement. It typically means when you have missed a payment to the loan or if you are entering into bankruptcy proceedings. It can also include breaking covenants (discussed below)
Restrictive Covenants — A restrictive loan covenant is simply a statement in the loan agreement between the lender and borrower stating that the small business can and cannot do certain things while it is paying on the bank loan. Examples include taking on additional debt without prior approval from the creditor.
As one of ATX’s go-to startup lawyers, I’m happy to assist in explaining the ins & outs of loans as best I can. You’re not alone in navigating all this. Stay tuned for Part 2 of this blog, where we’ll focus exclusively on revenue sharing loans.