When should you raise funds and what can be the debt-equity ratio? Experts answer

Running a startup is no easy feat. There are several issues to tackle and questions to answer. One such question that founders often struggle with is—as a startup, when should you look at raising funds?

Even if that pertinent question is addressed, there still remains the contentious issue of debt vs equity, or what should be the funding ratio.

At TechSparks 2022, the 13th edition of YourStory's flagship startup-tech summit, experts came together to answer some of these questions. Blume Ventures Partner Ashish Fafadia, Alteria Capital Managing Partner Punit Shah, and HSBC Director and Country Lead Tech—Commercial Banking Dilip Gopinath dived deep to demystify some of the common funding fears.

Ashish said, "In terms of fundraising, the fundamental thing is—what is one raising for, what is the value proposition, and what is one building towards."

According to Ashish, one should go for funding only when they are in a position to narrate a story about it, what big problem they are solving for, and why they are walking down that street.

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With equity financing, there is no loan to repay. The business doesn’t have to make a monthly loan payment, which can be particularly important if it doesn’t initially generate a profit. This, in turn, gives one the freedom to channel more money into the growing business.

On the other hand, debt financing happens when a firm raises money for working capital or capital expenditures by selling debt instruments to individuals and/or institutional investors.

Talking about the funding ratio, Puneet says, “If you are a founder, you are going to build the business in the next ten years, and you will need to raise hypothetically $60 million to $70 million. Now, one can break down this amount to $30 million in equity, and $10 million to $20 million in debt. That's the impact from a dilution perspective.”

Speaking about the pros and cons, Ashish explains, "The advantage of equity is that this kind of source of capital is there to stay with you and one can use it for formative years of their journey, building their product, forming the initial team, and in marketing and sales funnel. And there is never going to be an expectation to physically repay that amount. Either it is going to be a future investor who, in the next few years, will buy that equity and exit as an early investor, or hopefully, the right way for the company is to go for IPO."

"The disadvantage of equity is that it brings with itself dilution. The advantage of debt is you can build without the dilution aspect of the business but then it brings with itself a certain responsibility that there is enough cash flow in the business," adds Ashish.

Explaining further, Dilip says, "One of the advantages of debt capital is that bankers bring in a lot of governance in business operations. We don't get into the board to look after how to run the business or startup but what we ensure is that the finance team is on top of the game in terms of ensuring that working capital utilization is performed. So, banks can give you the flexibility of different instruments and it brings in a kind of discipline in your operations. But the con is bank debt is not scalable."