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The Best Time To Use Loans To Start Or Grow Your Startup

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Startups are risky. This explains why you don’t see most entrepreneurs running to the bank for loans to fund their ventures. But everyone talks about fundraising. After all, with a few exceptions, none of the startups and founders we look up to today scaled their startups without large sums of money.

Most entrepreneurs evaluate their funding options from a risk minimization standpoint. When a startup funded by investors fails, entrepreneurs lose the time they invested to start and run the venture up until its failure. However, when you use loans to fund a startup, failure doesn’t eliminate debt and for as long as it will take, you need to pay back what you owe. What about in cases of success? Most of the time, this is when every unit of equity sold becomes more expensive than an amount that could have been borrowed.

There’s a middle ground. Startups are risky but not every aspect of building a startup is a life or death situation. As such, combining risk minimization strategies with the right amount of debt and the right amount of funding at the right time will help you better balance risk with reward over the short and long-term.

Before discussing the right situations for obtaining startup loans, here are a few investments you should not get a loan for in the early stages of a startup venture.

  • Starting A Startup

If you are in the earliest stages of starting your venture, this would be the worst time to get a business loan. First, since your main goal at this stage is to validate an idea or a hypothesis, backing the potential of your venture on this idea is not a smart decision. Ideas are guesses until validated.

In order to validate an idea, there are many steps that you can take before investing in product development which tends to be one of the costliest parts of starting a startup by non-technical founders.

Instead, spend a few weeks speaking with potential buyers, presell your product and see if people are willing to prepay for a solution that does not exist. If you are successful at preselling your idea, design a plan that combines manual work with existing tools to solve your buyers’ problems by doing things that don’t scale in the beginning.

  • Building An MVP

Nowadays, whether you consider yourself a technical or non-technical founder, there are many no-code tools that have all the needed features to help you quickly turn your ideas into testable hypotheses. One of the mistakes that most entrepreneurs make is deciding to build an advanced version of the product just because a few people complimented their ideas and prepaid for it.

The truth is, on average, the difference between a basic functional MVP and a slightly more advanced version can be a matter of a couple of weeks of work but many entrepreneurs decide to skip the slightly more advanced version to aim for one with more features and better user interface. This takes time, money and definitely not the right situation for business loans.

  • Substituting A Stream Of Income

Using a portion of your monthly income to fund the early stages of your venture is the best bootstrapping channel you can have. Unless you have built enough traction to justify quitting a job, buying time through loans will not make a big enough difference in accelerating your path to first or next paying customers as compared to running your startup on the side for the first six to twelve months.

On the other hand, loans can serve as accelerators in many business situations. As you’ll find below, the best time to leverage loans to boost business performance is when you need to make an investment that has high success predictability. Here are a few investments you should consider getting a loan for.

  1. Accelerating Customer Acquisition

It takes time and money to validate an acquisition funnel that works repeatedly. One that is backed by data and proven results. With such funnel, it can be a safe bet to use a loan to increase the advertising budget especially when you know that for every X dollar you invest you get a multiple in return.

Funding, in this case, will not only help you acquire more customers faster, but chances are, many other potential customers or leads will learn about you which can progressively reduce your customer acquisition cost the stronger the brand you build. Also, make sure you evaluate your borrowing decisions by looking at your customer lifetime value and churn.

  1. Recruiting Key Player(s)

This comes with a caveat. The ideal scenario, especially for early-stage startups, is when the founder(s) has successfully started and proven the business on a tight budget where certain key areas like product development and marketing produced promising results even without the involvement of a dedicated team. In this case, a new hire with the needed knowledge, experience and expertise can only help the startup move faster on stronger foundations.

Hiring an expert to figure things out before execution is costly. Instead and in the meanwhile, seek the advice of a mentor to find what works and then hire someone to double down on it.

  1. Expanding Through Acquisition(s)

The typical acquisitions we all hear about in the news tend to be about giant startups or large companies acquiring multi-million dollar startups. The reality is that we never hear about most smaller acquisitions even though there are many more of them.

Some acquisition opportunities are worth considering even at a smaller scale. If the target is profitable and generates sufficient revenue, it can make sense to borrow the acquisition funds and, in the beginning, use the acquired company’s profits to pay back the loan. Successful acquisitions can increase the value of your company quickly and save you significant expansion resources in the future.

In sum, there are many ways to use smart debt to grow your venture. As a rule of thumb, consider debt to invest in response to demand not to test new ideas. Leverage existing resources to find what works and use debt to fuel a stronger and more impactful execution.

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