One of the biggest challenges in establishing a successful startup is raising capital. Start ups have challenges raising not only enough capital to start the business but to maintain it especially as the business establishes a stable market and steady income. Startup founders use several ways to raise capital which can broadly be divided into two; equity finance and debt finance.

Equity Financing may include raising the capital from friends and family or personal savings while Debt Financing may include getting bank loans or venture debt which is repayable once the business takes off or exchanged for ownership in the business. However, businesses sometimes don’t take off at the speed and momentum envisioned by the founders. This can often leave the startup, like the participants in Netflix’s Squid Game, gasping for air as it languishes in massive debt. 

This is why every startup founder or manager needs to make well thought out decisions as it relates to acquiring, servicing and sustaining debt finance. These are some of the things a startup ought to consider before raising debt finance;    

Nature of the Creditor

Not all Creditors are the same. When it comes to banks; they each have different loan terms, loan amounts, loan durations, enforcement procedures and capacity for negotiation. Even in the Banking Industry, not all banks lend the same, some are more open to giving higher loans with lesser collateral. Banks also have varying interest rates. Secondly, when it comes to enforcing delayed payments some offer more room for negotiation than others. An example of this was during the Covid19 when some banking institutions gave longer repayment holidays than others. [1]

If the financing is based on Venture Debt, then it is important to analyze the funding agreement, more often than not the Venture Capital funder will have a higher priority than the Banks. This makes it important to also scrutinize the Venture Capitalist intending to finance a startup. Their past interactions with other entrepreneurs and the amount of buy-in agreed with the Venture Capitalist will have a great impact on the financial health of the business. Some of the popular Venture Capital Firms in Kenya include Novastar Ventures Ltd, Fanisi Capital Ltd, Safaricom’s Spark Fund, Viktoria Ventures, Savannah Fund and Afvest Invest. 

Each of the firms has a different mode of operation and areas of focus which means that it’s important to find the right fit. For example, Fanisi Capital has a bigger portfolio and more resources to use thanks to being financed by the International Finance Corporation. The con with such a big outfit is that it may lack the personal touch of a personally invested venture capitalist. While others like Viktoria Ventures have a smaller portfolio but might have the benefit of a more personal touch and emotional investment in a startup.

Debt Servicing Plan

The second important thing for a startup that has raised capital through Debt Finance is having a proper plan on how they intend to repay the credit extended to them, down to the tee. It is also important for a start-up with multiple loans to consider debt counselling where they visit a professional to assess their debt health. The assessment would evaluate the health of the business by analyzing the debt they owe, income and offer solutions as to how the debt can be restructured if need be.   

Debt Conversion

Another important strategy that a startup can adopt is to have debt conversion arrangements where both venture debt and bank debt can be converted into shares in the startup at a later stage. This is both a lucrative and dangerous strategy so the startup founder has to balance between avoiding possible debt overburdening in future and maintaining control of the business.  

In conclusion, debt financing, despite the negative emotions it evokes is still a viable method of raising capital for a startup. When proper care is taken while choosing a financier, structuring the financing arrangement and converting the debt into shareholding without losing ownership, debt financing can be a viable means for raising capital for a startup.


Published by masibolaw

We help ambitious entrepreneurs to overcome legal and regulatory obstacles while growing their businesses.

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