Debt Guide for Early Stage and Late Stage Startups

Debt financing is an essential tool for startups looking to grow and scale their business. In the early stages, access to capital can be limited and more expensive, but as startups grow, more debt financing options become available. For fintech startups, in particular, debt financing is crucial as they need to offer financial products to generate revenue. However, the debt financing process can be complicated, and it’s important to understand what lenders look for and the various options available. 

In this blog, we provide a comprehensive guide to debt financing for both early stage and late stage startups, including what debt options are available, what lenders look for, and how startups can move through the debt capital process.

Early Stage Debt for Startups (Pre-seed to Series B)

In the beginning, startups, especially those in fintech, need to concentrate on how capital can help them grow. The tradeoff, though, is that they might need to pay a higher price for capital to get a more extensive facility to achieve scale.

What Debt is Available for Early Stage Startups?

In the earliest stages (Series A, seed, and sometimes pre-seed), companies have access to a variety of debt options, but the cost varies. Founders, in most circumstances, should raise at least a seed round before trying to raise debt. As the company grows and raises subsequent equity rounds, debt financing options become more available, and the facility size increases. This leverage enables startups to negotiate more favorable debt terms.

Bank loans are typically the cheapest option, but banks expect a long-term relationship, and there may be limits on the total amount raised. Asset-backed financiers, however, may provide larger facilities and reduce the debt expense as a company scales. Some banks have separate groups for corporate debt and asset-backed lending.

What Do Lenders Want to See in Early Startups?

Since seed companies are considered high-risk, lenders heavily consider the quality of the seed investors and their belief in the founding team. Asset-backed debt lenders will also require evidence supporting the creditworthiness of the end customers using embedded financial products and services. At the very least, lenders and asset-backed financiers require some VC backing or other institutional capital invested in the business, particularly if it’s a loss-making enterprise (selling products at a loss to gain market share).

Debt Options for Early Stage Fintech Startups

For fintech lenders, capital is crucial from the seed stage, since they need to offer financial products like loans to generate revenue. To save costs, early-stage fintechs often opt for debt facilities instead of equity for funding. As fintechs scale their loan originations, they require more capital, and raising debt seems preferable to excess dilution. But raising debt can be a problem for early-stage startups, as they need to provide loan origination data to secure a loan.

To resolve this, fintech startups use a portion of their seed equity funding to demonstrate their underwriting capabilities and build their loan tape. Once they have a solid loan tape, they have a better chance of raising a term loan, a line of credit, or a warehouse facility. After raising a Series A, they can refinance their debt with a larger facility.

In some cases, startups with strong investors and experienced teams can secure corporate debt, such as a term loan or a line of credit, provided they can show the creditworthiness of their customers. These facilities are typically given at around 30% of the equity raised. However, most startups use this capital temporarily to demonstrate their origination programs before taking on a larger facility.

In rare cases, startups can raise warehouse facilities if they can demonstrate the creditworthiness of their customers and show a path toward significant origination volume. For example, a fintech lending platform can provide financial analytics and operational software to businesses with strong credit profiles, providing unique insights into the financial health of customers and equipping the platform to offer lending products.

To win favorable terms on their first facility, companies often speak to multiple early-stage debt investors. Based on lender conversations, a general rule of thumb is that projected origination volumes should be at $20M+ within the first 12 months. While banks may need more data to underwrite underlying assets for asset-backed facilities, they can also provide a smaller amount of corporate debt for origination in the early stages.

Raising Early Stage Debt Capital Example 

Now, let’s consider a hypothetical early-stage fintech company that offers a loan product. The company has just raised a seed round of funding and wants to raise capital through debt facilities to extend loans to its customers.

To begin, the company would start by using a portion of its seed equity funding to demonstrate its underwriting capabilities and build its loan tape. Once the loan tape is built out, the company can approach debt investors for a term loan or a line of credit.

The company needs to show the creditworthiness of its customers to secure corporate debt. They can achieve this by providing supporting evidence of the credit quality of the end customers of their embedded financial products and services. They can also showcase the quality of their seed investors and their conviction around the founding team.

Based on lender conversations, projected origination volumes should be at $20M+ within the first 12 months to win favorable terms on the first facility. However, banks will need more data to underwrite the underlying assets for an asset-backed facility. Therefore, the company may start with a smaller amount of corporate debt, which can be applied to origination in the early stages.

As the company scales and originates more loans to its customers, it’ll need to raise more equity to fill the gap in capital for an asset-backed facility. If the company is able to demonstrate the creditworthiness of its customers and show a path toward significant origination volume, they may be able to raise a warehouse facility.

Late Stage Debt for Startups (Series C+)

As startups grow and scale, lenders become more open to conducting detailed analysis, which expands the range of debt financing options available to the startups. As a result, the debt capital changes in the late stages after a company scales.  

Corporate Debt for Late Stage Startups

As companies grow larger, corporate debt becomes a more appealing option as it provides access to larger facilities and lower cost of capital. Late stage lending is primarily sourced from credit funds and banks. Credit funds provide flexible solutions, such as term loans, convertible notes, and convertible/structured preferred equity, while banks offer lower-cost-of-capital solutions like revolving credit facilities and term loans.

Profitability is not always required for late stage corporate debt, but it certainly opens doors to a broader range of private credit. Lenders will underwrite based on implied enterprise value, utilizing conventional metrics such as EBITDA multiples. Late stage companies that haven’t achieved profitability are evaluated based on factors like investor syndicate, revenue scale, growth metrics, customer base, retention, and market position.

Corporate debt is typically monitored through financial covenants, which come in various forms of liquidity and operating tests like interest coverage ratios, revenue, EBITDA, or cash flow performance. Syndicated loans are a common option, where a group of lenders commits $100M to $500M, structured and administered by a lead arranger bank.

If a company is preparing for an IPO, it’s crucial to leverage investment banking relationships to establish pre-IPO facilities with favorable terms. Once a company is publicly traded or of a certain scale, it gains access to high-yield debt offerings and public convertible debt in the credit market, providing scale, flexibility, and access to a different set of debt investors.

Asset-Backed Lending for Late Stage Startups

As companies generate more loan origination data, cheaper asset-backed debt options become available and late stage companies can broaden their range of potential lenders. Securitization is a popular option at this stage, especially if a company’s performance data qualifies for ratings from rating agencies like Moody’s or S&P. Private credit lenders, including insurance companies, can leverage ratings guidance and comparable public companies to source capital from banks and insurance companies at a lower cost.

Securitization typically offers the lowest cost of capital and enables companies to sell loan assets, transferring balance sheet risk to financial institutions. However, securitizations usually come with more restrictions, including increased eligibility criteria, deleveraging requirements, and other performance covenants. Additionally, the securitization process requires advisors to build a book of demand, which can be time-consuming and costly.

First-time securitization issuers generally seek a receivables portfolio of at least $150 million (with run-rate originations to support and grow to that level), although the amount depends on macroeconomic factors and the duration of assets. For instance, a BNPL product paid back in four weeks instead of six months can enable faster capital recycling. Shorter duration assets usually require a larger book or revolving structure to keep investors’ capital deployed.

Later stage companies expanding into multiple products and geographies can use asset-backed lenders to offer small test buckets that enable them to utilize a portion of their asset-backed facility to build performance data in new products and geographies. With enough data, these new products can be incorporated into the broader facility without additional restrictions. Companies expanding into different countries can set up a master special-purpose vehicle in a warehouse facility to cover all their needs or separate vehicles to handle different currencies.

Structuring asset-backed debt can be complex and expensive, so it’s important to have counsel who understands the company’s unique circumstances and has expertise in this area.

Raising Late Stage Debt Capital Example

Let’s return to our hypothetical company from earlier. It’s been a few years and the company just raised its Series C and has a strong track record of loan origination, generating predictable revenue streams. As the company has grown, it has attracted interest from a range of potential lenders and is looking to expand its range of debt financing options.

At this stage, the company has several options for accessing corporate debt financing. It can approach credit funds and banks for flexible solutions such as term loans, convertible notes, or convertible preferred equity. These options can provide the company with the necessary capital at a lower cost than equity financing, allowing it to scale up its operations.

The company’s profitability will be a key factor in determining its eligibility for corporate debt financing. If it is profitable, it will have access to an even broader universe of private credit lenders. These lenders will underwrite the company’s debt on the basis of its implied enterprise value, using conventional metrics such as multiples on EBITDA. For example, a profitable fintech lender with $50M EBITDA could receive a debt quantum of 3-4x EBITDA, or $150M- $200M.

As the company continues to grow and expand, it may consider transitioning to cheaper asset-backed debt solutions. This could include securitization, which would allow the company to package its loan assets into a security that can be sold to financial institutions. This would enable the company to sell its loan assets and transition balance sheet risk to other parties.

Final Thoughts

Startups can benefit significantly from debt financing, but they need to be aware of the trade-offs and the different debt options available at various stages of their growth. For early stage startups, debt financing can be more expensive, but as they grow and raise subsequent equity rounds, more favorable terms become available. Late stage startups can access corporate debt financing, including flexible solutions like term loans and convertible notes, and cheaper asset-backed debt solutions like securitization. Overall, it’s essential for startups to work with counsel who understands their unique circumstances and has expertise in structuring asset-backed debt.

Frank Gogol

A seasoned SEO expert, Frank has a long history of working with and for startups. Starting in mid-2018, Frank served as the SEO Strategist for Stilt, a fintech startup that provided fair loans for immigrants in the US and other underserved markets. While with the company, he scaled site traffic from zero to more than 1.5 million unique visits per month, driving the bulk of the company’s lead generation until it was acquired by J.G. Wentworth in December 2022. As employee #5 at Stilt, Frank was witness to, and part of, the successful building and sale of a fintech company, uniquely positioning him to create content for founders about all things startups.

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