Start-up financing

In the current economic environment, new companies are being founded every day. This is a clear sign that innovation and growth are taking place in our environment like never before. One of the biggest challenges facing start-ups is finding the right financing: young companies face the challenge of raising sufficient funds to realize and scale their business ideas.

A basic distinction can be made between equity and debt capital when it comes to financing. If the founder only brings equity into his company, in other words his own money, he bears the full entrepreneurial risk himself. In return, he receives a share of the profits and retains control of the company. If debt capital is brought in, e.g. in the form of a loan, this corresponds to a fixed repayment amount and interest. The lender does not bear any entrepreneurial risk per se, but does bear the insolvency risk of the company to which it provides a loan.

The question that arises in the context of financing is in what form capital is brought into the company, or in what ratio equity or debt capital is raised. This requires a few considerations. Equity capital, for example, has high capital costs from the owner’s point of view because additional equity dilutes the founders’ voting rights. On the other hand, it can counteract the problem of over-indebtedness by providing the company with a financial cushion. Raising debt capital has no effect on voting rights, but changes the financial security due to the increase in liabilities.

In the case of start-ups, the risk of the lender, who has no external collateral, is very close to the equity risk, as repayment is not possible if the company fails (bankruptcy). Investors want to be compensated for this risk. The cost of debt capital thus approaches the cost of equity. In addition, pure debt financing is practically unavailable for start-ups because the investor also wants a say in the risk. To resolve this conflict, the capital structure can be designed with voting and preference shares to reflect the interests of founders and investors. It can also be expedient to conclude a shareholders’ agreement so that both the interests of the founders and the interests of the investors are secured on a contractual basis.