Business loans and credit cards are always your startup's good friends, whereas VCs are not

How can financing options like business credit cards, loans, or line of credit help improve cash flow?

Note: This article continues the cash, cash flow, and startup article.

The previous article must be read to fully comprehend this one.

Cash flow is often a problem for new or small businesses because they may not have easy access to financing or a steady stream of income yet. Also, there may be no cash reserves or only a limited amount.

This can make it hard for them to meet their financial obligations and invest in their operations, which can slow their go-to market, growth, and success.

If a startup or small business is experiencing temporary cash flow issues, it may be able to resolve them by utilizing financing options such as obtaining a loan or borrowing money from a line of credit.

Business credits, loans, and credit cards can all potentially help to improve a company's cash flow by providing it with access to additional funds that can be used to cover operating expenses, invest in new equipment or inventory, produce more products or services, add more features, hire more people, spend more on marketing and sales activities, or take advantage of new business opportunities.

Borrowing debt means using a financial tool like this to get cash.

A business can use the proceeds to cover short-term cash needs or make a long-term investment in the company.

If you take out a loan, you will be able to inject ready-to-use money into your cash flow, and you will be able to repay the loan over a period of time (monthly or quarterly) in small amounts through instalments. You can also agree with the loan provider to pay a lump sum at a later date.

Similarly, if a business uses a credit card to make purchases or pay for operating expenses, it can delay payment until the credit card bill is due, which can help to improve its short-term cash flow with some short-term flexibility.

Unusual fintech companies even let you pay for your spending in monthly installments. This allows businesses to spread out their payments over a longer period of time.

An example of how a debt instrument, such as a loan or credit card with instalments, can help your company's cash flow

Assume you have a $30,000 monthly recurring (monthly) expense due in January 2023. 15k in wages, 7.5k in rent, and 7.5k in marketing and sales. You also have $100,000 in cash in your bank deposit account that is ready for use.

If you pay $30,000 from your cash reserves, which total $100,000, you will have $70,000 in your bank account.

Because $30,000 is a monthly recurring expense, adding the next two months, February and March, to January will cost a total of $90,000 ($30,000 x 3 months), leaving $10,000 in the company's bank accounts after the expense payment in March.

You've also made a sale and expect to receive $150,000 in accounts receivable from your customer in April and May, which will help your cash flow significantly.

To avoid the risk of having to keep the business going with only $70,000 in the bank after paying January expenses while your monthly expenses in February and March will also be around $30,000, it will be wise to inject some cash into your cash flow. Applying for a $60,000 loan if the interest rates are low or acceptable can be a good option.

This way, you can borrow $60,000, add it to the $100,000 already in your bank deposit account, and increase your total available cash to $160,000. You can repay the $60,000 loan to the bank in 12 months, allowing you to pay your expenses in January while spreading the back payment over 12 months.

This allows you to keep your $100,000 cash reserves in the bank for longer for any other needs that may arise in the future, while also utilizing the resources of the bank or another financial institution to deal with any cash flow problems that may arise between January and April.

And after you pay your expenses for January, February, and March, a total of $90.000, there will still be $70.000 in your bank account to cover expenses that will occur after March, until you can collect your $150,000 account receivable.

Many business owners think that carrying any debt is inherently risky because they have to pay interest. This is not true.

It is a common misconception that you should use your own company's funds for growth, such as cash reserves or investor funds, rather than a bank loan. But this is also incorrect.

Debt financing could be a good option for businesses that want to grow if the interest rates are reasonable and the company can expect to make more money or get a better return on its investments.

If you want to figure out whether or not taking out a loan will be beneficial to you, you need to know how much you can expect to pay in interest and other fees.

It's crucial to carefully consider the terms and conditions of any credit, loan, or credit card, as they may come with high interest rates or fees that can change the total cost of borrowing.

Borrowing comes with its own set of dangers, such as the possibility of default if payments are late, so it's important to keep an eye on the big picture.

Overall, business credits, loans, and credit cards can help a company's cash flow by delaying payments from the company's bank account and spreading them out over time. However, they should be used with care and as part of a well-thought-out financial plan.

Another quick note before moving on to the next section.

A convertible note can also be used to fund a business. In most cases, it is a better option than an equity round for the company and the founders. However, it is not always preferred by investors because it is not advantageous to them because it carries more risks. Convertible notes are debt instruments that can be converted into equity in the short term. Instead of regular payments, convertible note holders receive interest in the form of discounted equity shares. Convertible notes, on the other hand, do not give VCs enough rights and can be repaid, so they are not preferred unless VCs are extremely interested (or desperate) in investing in the company. Because convertible notes aren't as common as equity rounds with SAFEs, I'm not going to discuss or include them as a way for the company to raise funds in this article.

Which is better for your startup company or small business, debt (loans, credit cards, other borrowing) or equity (selling your shares to investors/fundraising), and how can you tell?

When borrowing money(a loan) is better than getting money from investors or raising money

As mentioned earlier, the predictability or unpredictability of the return on investment in your business operations should help founders in determining whether to use loans or credit cards or sell their shares to investors in exchange for cash when the business is in need.

Why would you sell shares that have proven to be valuable and will only go up in price over time?

Especially to those (investors) who will give you money once or twice today in exchange for shares in your company and then sit back and enjoy the fruits of your labor, revenues, and profits for the rest of your life without ever contributing to them. Starting today, you will give them 15% of everything you earn for the rest of your life. You may not give them this 15 percent in cash, but they will be the owners of this portion.

This transaction is expensive for the company, its founders, and shareholders. They will be giving up shares that will become more valuable in the future.

The answer to the above question is no. If things are predictable, selling shares to investors may not be a good idea unless it is the last option and you are waiting for the best time to sell, which is the highest value of the company's shares.

A group of strangers who do nothing but profit from the company's work and success. It's a bad deal.

When in need, consider less 'expensive' alternatives to selling your company's shares, such as borrowing or investing some personal savings (less popular, but why not) to provide the cash the business needs because you are confident that injecting more money will result in profits or growth, and you would keep your shares.

Banks will provide a loan or a business credit card if you can prove that your business has done well in the past and will do well in the future. Or if you have cash reserves in your bank account.

When a positive outcome from how you use this borrowing is very likely, the risk is low. A good outcome can vary depending on the business and its margins. Making more money than you pay in interest on the loan you take out to fund this operation may make things acceptable or good.

In general market or economic conditions, a business loan will cost between a few percent and ten percent.

The total interest you pay on the original loan amount will vary depending on the loan provider's interest rate. This is nothing compared to the first option, which is to sell your shares to investors.

However, if you don't know what will happen with the use of money in the business, whether it will make money or lose money, it may make more sense to raise money through an equity round, in which you sell some of your shares in exchange for cash and use their money. This is due to the fact that the outcome of the business operation is unknown and therefore impossible to predict.

In this risky situation, both investing your own savings and getting a loan or credit card with extra interest are risky because you may not get the money you put into the business back and lose your money, or you may not be able to pay back the loan or credit card debt, causing your business to go bankrupt.

Cost and value of loans

Loans, credits, and credit cards are all things I am a big fan of as a co-founder and partner at multiple companies.

I also try to utilize them as much as possible in my personal life.

Most of the time, they are free or inexpensive.

When compared to raising capital from investors in exchange for equity, borrowing money has always been more cost-effective if your revenue is sustainable, growing, and you are profitable.

They are cheap because, while you will pay the interest on the loan or credit product with your profits, you will only do so for a limited time and for a specific and pre-defined amount. You will not, however, be exchanging your shares for cash or a deal in which an investor receives a percentage of everything you earn in the future, whether it is nothing, $100,000, or a billion dollars.

Calculating profitability or returns can be hard for new businesses and businesses that regularly put their profits back into growth. This makes it difficult for the founder to choose between loans and fundraising to finance the business.

To understand how my business is doing in terms of returns, I would look at my company's operating profit margin or net profit margin, as well as customer segmentation, customer acquisition costs, and customer lifetime values, to figure out what has been going on.

I would not use the gross profit margin because it does not account for research and development, marketing, and administrative expenses. These are important numbers to know in order to understand a company's current operations, such as acquisition cycles and levels of scalability, as well as the costs of R&D and the improvements or opportunities they create now and in the future.

After reviewing the financial information provided above, if your co-founders or business partners believe you are running a profitable business with the potential to grow revenue or customer base without significantly reducing margins, and financial numbers support this, the value of the shares you already own in your company has increased and/or will continue to increase as the company's revenue grows.

In this scenario of a growing business with a profit margin, using debt instruments to meet your cash needs for expenses or growth may be the best way to meet your cash needs because the value of your shares is constantly increasing, whereas if you get money from an investor or fund raise, you will have to sell your shares at today's price, knowing that they will be worth more in a month, three months, or six months.

This way, as a founder or partner, you can hold on to your shares until you can sell them at the best time. The best time is when you can no longer get enough money from debt and your month-to-month growth has been at its highest for the last couple of months. This will allow you to raise money with the highest possible valuation for your company while selling a smaller percentage of shares for the same amount of money.

One risk here is that if investors see that you are in desperate need of cash and only have 3–8 months left or less, they may force you to agree to shareholder agreements and valuations that do not maximize benefits for you—they will try to force you into a bad deal for you.

Loan and other forms of credit product amount limits have always been a major issue, especially for new or small businesses. Banks consider a company's previous cash flow, credit scores from previous transactions or loan use, and other factors such as personal savings and assets to determine how risky the company is and how much credit it can obtain.

Because they didn't trust us, no bank was willing to give us a loan large enough to cover our monthly, quarterly, or annual operating costs in the early days of some of our companies, when we didn't have much or any money coming in. That is why we have worked on improving our credit scores by taking out small loans and repaying them on time.

But after we started making money and kept growing, we always tried to use loans and credit cards if the interest rates and terms were good.

Fintech companies that focus on providing loans or credit cards to businesses have recently been basing their risk analysis and amount limit evaluations on a variety of criteria, such as cash reserves.

Traditional banks on the other hand cannot provide high limits to nontraditional businesses such as startups that have large amounts of cash in their bank account from fundraising but are not making any revenue, which is normal for every startup for 6 months or 2 years while building products/services and attempting to sell them due to their old school risk analysis. Because of this, new fintech companies that offer credit products and use non-traditional risk analysis may give startups and small businesses higher limits.

There are two interesting facts I have discovered about the need for money, whether through fundraising or borrowing money.

First, when we found a good product-market fit, we almost never needed urgent fundraising, big fundraising, or even fundraising, at any of the companies I was a partner at. Two of the most successful companies with large annual revenues in which I've been a partner and operationally involved never needed to raise funds, and the other only did so once in a seed round. Two of the most successful companies I've been a part of that make a lot of money every year (one makes over $10 million and the other makes over $50 million) have never needed to raise money, and one has only raised money once in a seed round. These are the proofs for the fact that startups often don't need to raise a large sum of money.

Second, when we needed funds and had time flexibility, we were able to secure funding from investors at very favorable valuations and terms. However, when we were in a hurry or didn't want to waste time, we made bad deals with poor valuations. With more time, you can negotiate better and come up with more options by meeting and talking to more investors. Never forget that valuations during fundraising are based on how good the founders or management team are.

It is critical to have time and not need the money urgently in order to conduct a fundraising round that protects the founders and the company from investors who try to get shares at the lowest possible valuations. When planning a fundraising round, it is critical to keep the runway at least 12 or 18 months long.

For pre-seed or seed companies, this may not be possible because they do not generate revenue or generate revenue that is insufficient to cover operational expenses. Part of the best strategy, however, remains the same: meet with all potential VCs before organizing a fundraise and asking for money.

When compared to trading our equity in return for cash with investors who want to benefit from our efforts only by providing cash, money that could help us grow our customer base 10% or faster month over month for 6 months and can be paid back in a 12- to 48-month time window with acceptable interest rates-loan or credit card-is always useful and a better option for a company that is growing rapidly.

What makes an interest rate acceptable is highly dependent on the situation and context. However, as mentioned previously, if the return percentage on your debt instrument investment is greater than the interest rate you will pay, that debt instrument is appropriate for use. For example, suppose you get a $10.000 loan with a 10% interest rate ($1000), and you invest this money in business and make a 15% profit ($1500)—you got the money you needed, invested it in business, paid the money back, and profited by 5%. And you still own all of your shares.

When you take out a loan, you are committing to repaying a large sum of money over the course of an extended period of time through a series of installment payments. This is a differentiator when evaluating both current cash flow requirements and future forecasts.

Because the payment for an expense can be spread out over a long period of time, businesses can reduce the impact that an expense has on their cash flow by using this method.

This can be especially helpful for businesses whose cash flow is inconsistent or limited because it lets them pay for things they need to run or grow without having to pay for everything at once.

An example of how loans or credit cards with instalments can be a better option for a company's cash flow and growth, be profitable for the business while also allowing founders to keep their shares:

Imagine this: in January, your company spends $30,000 to bring in 100 new customers.

In addition, each of those 100 customers will generate $40 in monthly revenue.

It will take 7.5 months ($30,000 / [100*40] = 7.5 months) for them to pay back the initial investment you have made to acquire them before they begin to generate a profit.

This company invested $30,000 in an acquisition in January, but it doesn't expect to see a return on its money until the end of seven and a half months, and it also doesn't expect to see any profit until the eighth month.

Since the company needs to spend at least $30,000 per month on marketing and customer acquisition in order to grow, this can have a significant impact on cash flow if the company doesn't receive the same or more income each month, or has sufficient cash reserves to sustain the expansion for an extended period of time.

If the company does not have to pay the $30,000 acquisition cost all at once to acquire 100 customers but rather can pay that total acquisition cost over a longer period of time with 12 monthly installments, the whole equation and cash flow challenge may change.

The sum of 30,000 dollars will be saved in the company's cash reserves, and the cost of acquiring the customers who were acquired in January will be paid every month with 12 equal payments, totaling 2,750 (I have added 10% of interest to the loan amount of 30,000 dollars, which brought the total amount that needs to be paid back to 33,000 dollars; this brought out 2,750 dollars in equal payments for a 12-month payback period).

Assuming the company will make $4,000 in revenue from these 100 customers, dividing the cost of customer acquisition by 12 months, and setting the monthly payment at $2,750, the company will be able to benefit from this operation from month zero.

The value of your company's shares increases as your revenue and customer base grow. And you keep all of your shares to yourself despite spending money, earning positive returns, and successfully growing your company.

This is how business loans, lines of credit, and credit cards with payment plans can help companies with cash flow problems in the beginning and help them grow faster and easier.

The ability to defer payments or expenses, as is the case with instalments, can be a helpful tool for startups, both in terms of helping them manage their cash flow and reducing the impact that expenses have on their budget.

I hope this is enough proof that, contrary to what most people think, financial tools like loans, credits, credit cards, and loans are actually very helpful for startups and small businesses that want to grow, even though they come with interest rates.

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Every business owner, founder, and entrepreneur should know how money works.

Financial literacy is a basic skill that everyone should learn early on when starting a business or working in certain positions and departments that directly affect expenses or earnings or manage or oversee company finances. It's like learning how to spell or read.

The money skills and habits you learn early on will help you all the way through your business career. And you can't be successful if you don't know how to handle money.

Cash, its movements, and how to manage it should be at the top of any founders’ and owners' list of required knowledge and skills, but it's a must-have for CEOs and CFOs.

Directors of companies need to always know how much money they have now and how much money they will need in different short- and long-term scenarios, both good and bad, if they want to stay in business.

With the global recession going on right now, this is more important than ever. No one knows how many years or even decades this will take.

With careful planning of cash flows and needs and careful cost management, a company can avoid financial trouble or even death.

Keeping a focus on building a quality product, penetrating the target market, and calculating costs and returns to grow your company in its early stages as a startup is what is required. Unnecessary expenses, excessive enjoyment of making money, and other similar distractions are all bad places to focus that can kill a business.

Not knowing, not attempting to make a concrete plan, or prioritizing making revenue as soon as possible to make money that is needed for the sustainability of your business operations is also a risk that can lead to failure. Remember that not making sales or revenue will result in complete failure. And, in order to survive, all businesses must generate revenue at some point.

Overall, managing your business and its finances, beginning with cash flow, should be the focus of founders for building and running a successful business that meets its financial obligations, invests in its operations, invests in growth, and achieves its long-term goals.

If a business has temporary cash flow problems and doesn't want to trade shares for money with investors or can't find investors quickly enough, it may be able to improve its cash flow by getting a loan or using a line of credit, where they can protect their cash reserves.

When deciding whether a loan or a fundraiser is best for your business's cash bottlenecks, there is one simple thing to keep in mind:

When you have a proven track record of investing in business operations and making money with strong margins, taking on debt on favorable terms may be the best option for the company because it is very predictable.

When you don't know how your business investment will turn out and the outcome is unpredictable, getting money from investors in exchange for shares can be a good idea.

Fundraising as a startup makes sense regardless of whether you are in the pre-product ideation, pre-revenue, or growing revenue stages.

However, if you are a growing revenue stage startup or business, you can benefit from a different approach, even if it is not the most common, accepted, or practical option in the field.

Why sell your company's stock to an investor or investment firm that will only provide you with a limited amount of cash once your company is doing well and can earn quality margins, even if you are not profitable due to reinvestment?

Investors are unknown strangers who benefit or profit from your work by doing nothing.

In exchange for your share and becoming a partner in your company, investors will do nothing else but provide you some cash now. As shareholders and partners, they will benefit indefinitely from your efforts because, as long as the company is in operation, you will be continuously and forever sharing the value you create with them-or working for them.

This may not be the best deal if you are confident that the company will generate new profits next month or in the future based on data and proof from previous revenue cycles rather than on intuition.

Looking for cash in a variety of ways to meet your short-term needs, retaining your equity, and not allowing some investor to share your success or gains by doing nothing forever or selling your shares to them at the highest possible price in the future should be the right approach for you as a founder.

Everything written above is correct. It's just not very common. The information, on the other hand, is exactly as presented.

Be aware of value, or your own value, if you want to get the most out of your efforts.

Even if you have received money from investors on a consistent basis since day one, have only received money from investors in one or two rounds, or have never received money from investors and do not intend to in the future.

Remember that you can build a business without the help of investors. Mailchimp, which was sold to Intuit for $12 billion in cash and stock, shows that a bootstrapped business can create a lot of value and have a great exit. Even though my life is short and my portfolio is small, it has happened to me more than once.

Fundraising is too costly for startups than business loans, credit cards, or some other options when the timing is wrong.

P.S. Cash is king only when you need it. If you have money but don't invest it, it will only bring you losses. If you don't have any money, borrowing can be practical and profitable.