3 ways startups can improve their chances of getting capital
As a founder or business owner, you’ve got more than enough on your plate running the day-to-day operations of your business. Financing future growth—whether with equity, debt, or alternative financing—adds an extra layer of complexity that many founders aren’t prepared for. Financing options for startups are out there, but coming to the table unprepared can quickly lead to problems getting approved.
Let’s take a closer look at the most common reasons founders get denied financing and what you can do to fix those problems. Whether you need financing right away or are planning for the future—which we highly recommend to anyone not actively seeking funds—keep reading.
The most common reasons startups fail to get financing
Whether your startup is profitable and needs funding to scale faster, or you’re still pre-profit and need outside funding to operate, a denial can be devastating. Traditional bank loans and equity rounds can take a long time and significant energy. If they don’t result in the financing you need, you may be running out of time to try again.
Here are some key reasons why startups struggle to get the financing they need:
Low cash runway
What is cash runway?
It's a measure of how many months you can go without an outside injection of capital. This is one of the key financial terms for startups to understand, because lenders and investor want to know your company will last. This applies to any company that’s not yet profitable, which can take years and is never achieved by over half of startups.
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How to calculate cash runway
Runway is how much cash you have divided by your burn rate (your net loss of cash each month).
Having a low cash runway can make investors worry about your operational efficiency and signal potential problems in the near future. Lenders and investors are hesitant to finance companies with low runway, out of concern the company may not have enough cash cushion to survive a few bad months. Those who will finance a company with low runway often do so at a much higher cost of capital to offset the risk for themselves.
Incomplete & inaccurate accounting
For an operationally focused or technical founder, bookkeeping and accounting may be the bain of their existence. All those spreadsheets can look like about as much fun as cleaning out the garage or organizing your closet. This is why so many put it off (along with cleaning out the garage and organizing their closet). For many startups, which have yet to put together an accounting team or hire a CFO, it can get put off even longer.
But timely, accurate accounting is an absolute necessity when you want to secure financing. Your accounting records are the easiest way for lenders and investors to assess the health and risk level of your company. Even if your company is in great health, if your accounting is a mess—or you haven't closed your books in a few months—lenders and investors won't know. For a financier, it can feel like choosing what's behind door number three.
A startup’s balance sheet is crucial when looking for financing because it shows lenders and investors what you own and what you owe. Cash on hand, existing loans, and other obligations all live on the balance sheet, and these are all important for financial approvals.
Updating and closing the books is also an important part of having an accurate balance sheet, because many of the adjusting journal entries that are made during the monthly closing process will impact balance sheet accounts. If these aren’t up to date, anyone reviewing the financial statements will have to make the most conservative reasonable assumptions about what those numbers are.
Profit & Loss statement
It may be even more important to have an accurate P&L for startups looking to get financed. That’s because a lack of assets on the balance sheet puts even more pressure on a healthy P&L startup companies can use to reflect cash flow, revenue, and expenses. These numbers help potential investors or lenders see your ability to repay as well as the potential for growth in your company (by evaluating things like acquisition costs and profit margins).
The business is too young
One of the most frustrating reasons your startup may struggle to get financing is because it’s, well, a startup. While early-stage equity investors are used to funding brand-new ventures, other forms of financing, like banks, want to see a long history of payments and financial responsibility. While financial irresponsibility is clearly a red flag, many startups are simply too new to have 2-4 years of financial records for a funding application.
How to improve your chances of getting business funding
Don’t let the struggles we’ve just mentioned get you down. If you want the best chance of securing financing for your growing business, there’s plenty you can do to increase your chances.
Banks, equity investors, and alternative financing providers are always looking for companies to finance. But first, they need to ensure those companies are healthy. Here are three steps you can take to maximize your approval odds and reduce your risk profile.
Show steady cash flow and cash on hand
What is cash flow?
Simply put, cash flow is the measure of cash moving in and out of your company. Cash flow measures only liquid payments, so while it includes things like checks and electronic payments (not only currency), it doesn’t include payments on credit that have yet to be collected. Cash flow is an important measure of a company’s health because a business that makes millions in sales but never collects the cash still can’t pay its bills.
How to calculate cash flow
There’s more than one way to calculate cash flow, but the simplest one (called the direct method) involves subtracting the outflows from the inflows in three areas: operating, investing, and financing. Your cash flow is the sum of all three. It’s also important to know each of these three cash flow numbers separately because you could be losing cash on day-to-day operations and only show a net positive cash flow because of investing activities (like selling equipment) or financing that won’t occur in a typical month.
Why cash flow is important in a business
A lack of cash on hand is a big red flag when you’re looking for financing. It can seem counterintuitive, as the need for cash is one reason you may be looking for financing, but there’s a good reason for it. For example, if you apply for a personal credit card, but you’ve used up most of your currently available credit, you'll be declined. The card company will likely decide you’re living beyond your means and will be a high risk with an extended credit limit.
The same concept applies to cash on hand and financing. Having no cash cushion can signal to banks and investors that your company is operating with no margin. That’s a big risk if the unexpected comes along.
Since cash on hand is part of the equation for measuring your runway, you need to have a decent cash balance showing you can operate through a dry spell. You can calculate your burn rate and runway using these simple formulas.
In the above example, you’d likely need to pay down your credit card balances first. As a startup seeking financing, you can improve your chances by tightening your burn rate to save up a cash cushion. You may also strengthen your cash position by seeking friends and family or small-check angel investment first.
Maintain a 12-18-month cash runway
A solid cash runway gives you more financial options by showing that your startup can survive to the next funding milestone. Maintaining a certain runway is challenging in tough times, but founders need to know what to shoot for as they secure funding and prune their spending to reduce burn rate.
While many banks and investors use 12-18 months of runway as a standard, it can vary by your industry and the type of financing you’re seeking. Ultimately, the longer your runway, the better off you are when it comes to obtaining capital. A company that has a healthy cushion and sticks to a plan to moderate burn will always be a more attractive financing option, giving you more choices and access to better terms.
Stay within a healthy level of debt
If you’re seeking debt financing, it’s important that your current cash-to-debt ratio is manageable. The cash flow required to service your existing debt will play into your burn rate and impact your ability to service more debt. Lenders will also consider the seniority of your debt and may be hesitant to lend if they’ll be subordinated to more senior debt.
Issues like runway, cash flow, and burn rate are all important factors to consider when you’re deciding on the type of financing to pursue. While each type has its place, none of them is right for every business in every stage of growth. Next, we’ll take a closer look at the types of financing, and consider which is best for your specific situation.
Choosing the Right Type of Financing for Your Startup
Now that you have an understanding of why startups may struggle to get financing, how you can prove that your business is healthy, and some of the key financial metrics that lenders and investors look at when deciding whether to extend financing, you need to think about the type of financing that fits your needs. Keep in mind that different forms of financing will have different requirements and be designed for specific stages of the business life cycle.
While you can raise equity rounds throughout the life of the business, it’s especially popular as a way to get started, because equity investors are looking at your future potential. While equity can cost more in the long run, it doesn’t have any up-front cash flow requirements.
Debt financing, including bank loans and revenue-based financing, will be a better fit once your business has consistent revenue. Lenders will want to see that you have the cash flow to service the loan payments, and, once you have that cash flow, you can preserve equity by using a method like this.
Pipe’s platform allows you to access up-front capital with your future revenue streams, without the common limitations of traditional bank loans or the dilution of equity fundraising. It works for a wide variety of companies with diverse types of revenue, and can even be used to extend runway and fund growth between equity rounds.
Getting the right financing when you need it
Whether you’re looking to grow your business or finance operations to keep your business steady, you need to find the right financing source and make sure you’re in the best position to get approved.
Take these steps to help you get there:
Decide which type of financing (equity, debt, or an alternative capital source like Pipe) is right for your type of business and stage of the lifecycle you’re in
Sit down with your internal stakeholders and do a mini internal audit to see where you stand with key metrics and what you can do to improve
Make sure your accounting books are closed, and up to date, so you’re working with accurate numbers and can show evidence of those numbers to a finance platform or provider
Assess your cash flow, cash cushion, burn rate, runway, and cash-to-debt ratio to make sure it fits the requirements of your chosen type of financing
Make wise use of the funds to ensure you stay healthy and growing until the next time you need funding.
Connect to Pipe, so you always know your capital options as your business grows.
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