By Patrick Woloveck
In today’s rapidly changing startup capital landscape, it is challenging for early stage entrepreneurs to structure the most efficient capital stack. Since I started focusing my career on alternative capital in 2018, it has been really interesting to see the conversation change about raising capital. As an (admittedly biased) champion for non-dilutive capital, I thought it would be valuable to share my experience. While not top of mind for many founders, these options can be leveraged to build your food startup alongside venture capital. To cover a broader spectrum, I also tapped into my network to leverage experts in their respective niches. Hopefully, this can serve as a small resource that yields the most money in your pocket after that BIG EXIT…
My company, VendorTerm, provides non-dilutive growth capital to startups. Traditionally, our model is defined as invoice factoring. If you have invoiced a big retailer for payment due in 60 days, VendorTerm will provide you a high percentage of the value of that invoice in cash upfront in return for receiving that total invoice payment in 60 days. We make money on the spread between. Managed properly, high-margin startups can ride this model all the way to exit without raising equity.
– Pros: Non-dilutive, quick, flexible, no commitments, scalable
– Cons: High cost of capital compared to a traditional loan
– Dilution: 0%
– My takeaway: The pushback against factoring is around comparing our cost to the APR of a term loan. That’s not an apples to apples comparison, as invoice factoring vs. term loans have vastly different risk profiles. Mainly, banks who offer loans have forms of recourse in the form of collateral, covenants, warrants, etc. The majority of factoring deals are non-recourse, meaning we hold all the risk in the event of default. This risk is priced accordingly, hence the wide discrepancy in cost of capital. Factoring serves more as an “a la carte” option on your capital menu which, in my experience, works well for startups who also like to be nimble. There is an opportunity cost to all financial decisions and ultimately the CEO makes the most fiduciary responsible decision for shareholders. Businesses with enterprise contracts, orders, and invoices that proactively manage cash by factoring receivables will reap the rewards many multiples over when it comes time to exit.
As you scale, your rocket ship food startup will receive purchase orders from big retailers prior to you ultimately invoicing them. You likely will not have ample inventory on hand, so you’ll need capital to pay suppliers in order to meet this new demand. Enter PO Financing. On the surface level, the deal is structured similarly to a factoring deal; however, due to increased supply chain risks, the terms are less straightforward.
– Pros: Still faster than going to the bank. Risk is passed along to the PO Finance provider.
– Cons: Your customers will be paying the PO Finance company directly
– Dilution: 0%
– My takeaway: This is a great short term solution. I would recommend reaching out to multiple firms, familiarizing yourself with the market, and having the best partner lined up before receiving the first purchase order from the big retailer. Many product focused startups combine both PO Finance & Invoice Factoring to combat cash flow hurdles while scaling.
Working Capital Loan
“A working capital line of credit is beneficial because it allows for the funds to be used for short term capital needs to help with the day-to-day cash flow of the business. They are a good way to fill seasonal or unpredictable gaps in the cash flow of business operations to cover payroll, miscellaneous maintenance, fill gaps between receivables, etc.”
– Brad Johnson / Director, Business Banking / First Republic Bank
When is a working capital loan applicable? All banks are going to have different standards and requirements, but net income will be much more important here than top line revenue. A good benchmark for the loan size is ~10% of net income, but it could be greater depending on the lender.
– Pros: There is flexibility with a line of credit so you are only drawing funds on an as needed basis, and you are only paying interest while the funds are outstanding. While it is easier to get working capital lines from non-bank lenders, there will almost always be higher closing fees and interest rates.
– Cons: Banks will typically be much more conservative with their lending standards, so for a startup, a bank will typically like to see 2-3 years at a minimum of consistent cash flow, and often will require a personal guarantee on the line of credit. Working capital lines can also fall short of your capital needs if you are looking for debt for long term accelerated growth.
– Dilution: 0%
– My takeaway: If you can get it, take it. Brad does a great job summarizing the tradeoffs of securing capital from a non-bank vs. traditional bank lender. IMO, this variety in options ultimately creates a win/win for the startup ecosystem. As lenders can optimize economics based on specific company niches and verticals, founders reap the rewards instead of a one size fits all capital product.
“Venture Debt is non-dilutive financing that companies can take on outside of raising equity. It gives you the ability to top off additional capital without being dilutive in order to extend runway, or can be an insurance policy when you don’t really need the capital.”
-Ruslan Sergeyev SVP, Venture Lending PacWest
We also interviewed Ruslan last year about when and why founders should optimally take on Venture Debt.
– Pros: Lots of variations available, not one size fits all
– Cons: Typically only offered on top of an equity round. Later stage. Minor dilution. More financial covenants depending on terms.
– Dilution: <5%
– My takeaway: The big takeaway that Ruslan consistently stressed was timing– the best time to consider Venture Debt is probably when you don’t need it. This is a principle that gets lost in the shuffle of the busy everyday life that comes with running a company. Just think about how many companies this year wish they had taken that extra capital insurance policy. Similar to my thoughts on PO Financing– I highly recommend reaching out to several firms in the market to familiarize yourself with the landscape. Some of the main players in this space include PacWest, SVB, and Signature Bank among others.
In summary, hindsight is 2020. The year is also 2020, and if there’s one thing I’ve learned, it’s to plan for the unexpected. Given the tremendous amount of uncertainty in the days, months, and year ahead, it is your job as a founder to be well versed in all the capital options available to you.