I've been hearing from a lot of founders and companies that are early in their development and eager to maximize shareholder return talk about the cost of giving up so much equity, or the high rates on debt that they're looking at (even in these times of ultra-available capital). Ultimately the discussion is related to the cost of capital. But what really is the cost of capital when looking beyond just the initial rate of return? In product sales, clients often have to be reminded that "price" is only one part of the deal. The same is true when it comes to financing your company. What are you willing to trade for price?

Here are some considerations.

With respect to equity:

    1. The money is the money, but what is the cost of having the wrong partner at the table, with interests misaligned to your vision and plan for the company? I worked with a company once where the founder had two offers. One was Canadian, with a team where relationships were already established, but had a lower valuation. The other was a U.S. private equity firm, providing a higher valuation, and a ruthless portfolio management team that regularly disrupted the existing culture to achieve its internal objectives. There's a cost to having the wrong partner at the table.
    2. What value-added services are coming with the money? You need to consider the value-added services, the network, and the advisory that will come with the investors. You may get easy money from an investor who doesn't ask many questions coming in and is light on due diligence, but what happens when you realize they are dead weight 18 months down the road or that they were short-term focused, or that they are on too many boards and you're not getting their attention when you need it?
    3. Have you considered the cost in time to manage phone calls, documentation, get signatures from, and update minority investors throughout your relationship? It might work short term to get lots of tiny cheques from friends and family or continue raising from angel investors on what is known as a SAFE (a simple agreement on future equity), or convertible notes, but what happens when things don't go to plan between funding rounds? Now you've got a complicated cap table (a summary of who owns what shares) and no one on it has dry powder in the form of reserved cash to follow-on. If you're eligible for debt, you may need existing noteholders or debtors to sign agreements to postpone their payback position, and if someone else is going to invest they will want you to clean up the cap table, reducing your administrative burden. These all have costs!

With respect to debt financing:

    1. Covenants, the specific terms of agreement, are an important part of negotiation depending on where you're planning to go as a business. If you're using financing to put into sales and marketing because you have a good grasp on the ratio of dollars spent to dollars received, then taking debt (that you're paying interest on) with a covenant that requires you to keep so much of it available in a reserve account may not make sense. Reporting could also be a consideration – grants may be available, but what are the reporting requirements? If you have to hire a person to manage the spend and it affects how you run your business and what you do with the money, you could quickly eat up the benefits.
    2. Personal guarantees are often a sticking point for entrepreneurs early in their company development. But wait, aren't you taking on risky debt because you believe your company is going to be worth a lot of money and you don't want to give up the equity too early? You're essentially trading risk for cost. If the viability of the business is still significantly tied to the founder(s) and not the business alone, shouldn't the terms be commensurate with the risk?
    3. Like equity, what is the cost of partnering with and managing the lender? If the economic conditions or your performance against the plan you presented changes materially, what is the cost of having to repay before you expected if your loan is called or doesn’t deliver the full amount of funds you'd planned for?

Consider, as well, the capital cost of more than today's transaction. There are implications for you downstream if you raise the wrong type or wrong amount of capital. If you have given up too much equity for your stage, it makes it challenging for new money to come in and investors to get their piece with confidence that you (founder/leader) are going to stick around. If you have too much debt, new equity investors may be concerned about new money coming in to clean up old problems rather than growth.

When considering doing any sort of transaction, go through an exercise of identifying what you must have, what you want to have, and what you're willing to trade. Since the market and funding environment is always changing, it's also worth getting several data points to compare before starting your negotiations. This will help you get a sense of what's realistic and not pompously over-negotiate before you have a deal worth talking about. I suggest modeling out different scenarios in order to understand the real cost difference (financial and non-financial) between different options now and over your lifecycle. Don't just take price at face value.

As always, drop in at the BDC lab to get a lay of the funding land and explore how we can help you think through a financing plan that keeps your bank account full and your company growing on plan.

Banknotes is an occasional column offering financial advice to startups.