Venture VS Debt by Szymon Janiak

The post was originally published in Polish on Szymon’s LinkedIn profile. Szymon kindly agreed to republish what we think is of great value to our readers.

Startups are looking for investors because no one wants to lend them money. In practice, this is a big problem that’s not widely discussed. Personally, I met many founders who gave away their shares at an early stage on unattractive terms because they had no alternatives. They wanted to grow quickly, they needed capital for operations or product development. It was too early for customers or the revenue didn’t generate fast enough. Grants distracted attention from the core business, and other funding would require huge time expenditures. An impasse was beginning.

I have heard many times that equity financing is better because it eliminates risk. In principle, this should be the case, but it’s not uncommon for contracts to have restrictions that in practice may generate greater claims than the value of the investment. What’s more, I met hundreds of people who were not afraid of this risk at all – they took it into account but believed in their product so strongly that it was not a problem at all.

I saw founders who, as soon as they reached the level in companies where they could count on debt financing, immediately let go of investors, seeing a lot of advantages in it. No non-financial obligations, full control over the company, freedom in spending funds, – these were the most frequent arguments.

The root of the problem is that nobody is willing to lend to startups at an early stage. Banks treat them like any other young company, and they don’t meet the requirements of the scoring model. A simple blocker is, for example, the requirement of a positive financial result for 2 years in a row, where the majority immediately reinvests all funds, generating losses. Other financial institutions have a similar approach. Business angels, on the other hand, grant loans convertible into shares, but ultimately aim to take up equity – after all, this is what they do. Venture debt is envisaged at a much further stage of development. There are virtually no public instruments of this nature at present.

It is obvious that the entire loan business is built on statistics – the resultant calculation of risk and collateral, but perhaps there is a solution here? Maybe instead of investing the vast majority of public funds from this sector to finance funds, it is worth returning to preferential loans for innovation and allocating some of them for this purpose? Such instruments were already used in Poland, but times have changed dramatically and perhaps this is the moment to launch it in an updated way? Over the last 5 years, we have historically spent the largest capital on startups in Poland – maybe it is worth considering supporting them in this way?

The comment section answers the question:

Loan funds from BGK for digitization/startups are already available, at only 2%, but it is not easy to obtain because they require a lot of collateral anyway. Besides, in the end it might not be enough anyway, because the analyst will not like the financial loss.

– Mateusz Sewastynowicz, CEO at Tripsomnia

‘They wanted to grow fast…’ – maybe not everyone should and maybe that’s part of the problem? Rapid development is one of the thoughtlessly accepted assumptions: ‘because that’s the right thing to do’, ‘that’s what everyone does’ (which isn’t true, only many remain silent), ‘the best did it.’ Of course, many ideas need a lot of funding to start with, because that’s what R&D requires, but that’s not always the case – a lot can be developed piece by piece and sold like that. This is related to another problem that you often raise – too much focus of founders on the technology itself.

Allowing founders to become more aware of the fact that slow growth can be a good way and an alternative that doesn’t need to be shamed (and showing good examples in this area) would also improve the statistics that banks use, which would allow for a gradual increase in the amounts that banks are willing to lend to small businesses.

– Wojciech Gołębiowski, Head of Space Tech at EXATEL

‘Grants distract attention from the core business.’

They don’t just distract you. I found out about other dark aspects of using various subsidies:

– Subsidies make people lazy… They are treated as ‘easy money.’ They aren’t respected in their own rite, and they aren’t pushing for a quick return as the investor’s money. They are often spent on equipment, not necessarily needed for business development. They postpone the need to catch business traction. Of course, if you are AWARE of these threats, you will avoid the trap.

– Especially EU programs often block the development of the company. We have written a nice project, we are happy at the beginning, but then our startup has to PIVOT. But in our application, we have planned a different path of the project and we have to stick to it. Resigning threatens with having to return the money already obtained. The continuation as originally planned may be a dead end, the market has changed in the meantime…

– Andrzej Wyzlinski, Founder at SitCare Consumer Health

I agree that access to debt financing at an early stage is difficult, but perhaps this isn’t the only problem. Startups are often not fully prepared to receive capital, regardless of its form. The lack of a solid business model, an underdeveloped product or the lack of a scaling strategy are factors that can deter both investors and financial institutions.

Maybe it’s worth paying attention to education and substantive support for founders to better prepare them for talks with potential investors and financial institutions? The introduction of mentoring programs that will help startups build solid foundations can be as important as the financial instruments themselves.

Additionally, the development of technologies such as artificial intelligence can open up new opportunities for startups. AI can help with risk analysis, optimization of business processes, and better understanding of the market, which in turn can make startups more attractive to investors and financial institutions.

I think that a holistic approach to the problem is crucial, which takes into account both access to financing and the preparation of startups to use it.

– Jakub Król, CEO at AI reveo