Startup funding: investment rounds vs. bank financing
The fact that a startup needs capital to grow is no mystery. By their very nature, these companies require funds to develop their business plans.
Before analyzing the advantages and disadvantages of the various options, there are two points I would like to highlight:
- First, these are not the only sources of funding available to a startup. In fact, public financing can be key to a company’s growth. From programs like ENISA or NEOTEC to grants, subsidies, and loans on favorable terms, founders should evaluate all available options, not only at the national level but also regionally and through specific programs aimed at certain sectors.
- Secondly, it’s important to note that there is no magic formula: each startup must carefully analyze the financing option that best suits its needs. Some companies, due to their sector or business model, can grow organically through bootstrapping, while others require significant capital injections that can only be obtained through investors who believe in their project.
Now, moving on to the details, we can consider two levels of analysis: the economic and the strategic/mercantile.
The economic analysis is based on the terms of the capital obtained (repayment period, interest, etc.). From this perspective, it is relatively easy for founders to assess which option is more attractive to them, as the criteria are purely objective.
The strategic/mercantile analysis is much more complex and depends on the specific situation of each startup. There will be cases where, due to their recent establishment, the startup has difficulty accessing bank financing without offering personal guarantees (which should be avoided if possible). It may also happen that an investor, in a pre-seed phase, not only provides capital but also valuable experience and connections, which can be especially helpful for novice founding teams. Additionally, it could involve an industrial partner who provides resources, such as manufacturing capabilities for future development.
However, this investment generally involves the investor entering the share capital, accompanied by specific conditions established in a shareholder agreement. This document will include clauses that regulate the relationship with the investor and, after negotiations, may incorporate rights that protect the investor’s interests, such as a preferred exit right or preferences in dividend distribution or in the event of liquidation.
This aspect is not necessarily negative; the important thing is that the rules of the game are clear. Sometimes, resorting to an investment round allows founders to raise a significant amount at an appropriate pre-money valuation, which propels the company toward new goals. Furthermore, bringing in well-known partners in the sector can provide valuable support for growth.
Therefore, we recommend that startups conduct a careful evaluation of the funding they will need not only in the short term but also in the medium term, in line with their business plan.
They should also carefully assess the available funding sources and design a strategy that combines the options that best fit the company’s needs.
If opting for an investment round, it will be crucial to prepare a solid investment deck and have a shareholder agreement that allows for negotiating the terms of the investment. It’s important to clarify all the terms in a convertible note or in the investment term sheet. In this blog, we have extensively covered these topics and recommend reviewing them if you are interested in delving deeper.
In this way, the founding team will be better prepared to successfully tackle the challenge of financing the company.