What is debt?

What is debt?

For many startup founders, intense focus and time is spent on building a product or service for customers and on raising equity rounds, but harnessing debt as a tool usually isn’t given the same focus and attention. We believe that is because there has not been as much education and knowledge sharing on the topic - we hope to change that. 

When you borrow money from an outside source and promise to return it, you take on debt. 

The term "debt" tends to have negative connotations due to the perception of risk and restrictions associated with taking the capital. While that can be true, these perceptions can often stem from a tendency to compare debt directly with equity capital, when in reality they’re very different and both have pros and cons. 

Why is it useful? 

Debt is also commonly referred to as “leverage”. However, the term leverage also has various applications outside of finance. In fact, startups are constantly trying to build up various forms of leverage in order to create a truly sustainable company. 

1. Leverage of Human Capital: hiring is often billed (and rightfully so) as the most important job a CEO has. Adding additional humans to the team gives the founders leverage. Instead of doing everything themselves they start to delegate roles and responsibilities to new hires, gaining leverage through labor. 
2. Leverage of Code and Systems: in an increasing digital and online world, every single startup either operates digitally or relies on 3rd party digital services. Each of these provides operating leverage through code and systems embedded in technology. Bolting on outside service providers immediately provides expertise in non-core areas at a fraction of the cost and time and usually are infinitely scalable. 
3. Leverage of Capital: decision making combined with access to capital provides an immense amount of leverage. More capital allows for father growth through speeding up the access to high quality human capital and code and systems. It could be argued that if you are proficient in managing capital, you would find managing more capital is even easier than managing more people.

For more detailed thoughts on leverage - read Eric Jorgenson’s excellent piece here 

Leverage of capital is arguably the most important of the three because without capital, gaining high-quality leverage of human capital and leverage of code and systems is extremely difficult. One major component of capital is of course equity capital. In these writings we’re going to largely ignore equity capital and focus primarily on debt (or credit) capital.  

Today, debt is ubiquitous. With so many structures and providers available, designing how debt and equity are utilized in a company can become a real competitive advantage.

What to be cautious about when raising debt for your start up?

Remember, lending relationships should be thought of as marriages. They are commitments that take a significant amount of upfront effort, provide mutual benefits for both parties but can be terminated if unsustainable after a period of time. As a founder, it’s likely that you will have many more conversations with your debt provider than a small non-lead equity investor. They are much more active relationships that require a high level of maintenance and care. However, when done right - with the right partner - they can be extremely beneficial to your startup.