Debt is a tool, and like any other — be it a hammer or handsaw — it’s extremely valuable when used skillfully but can cause a lot of pain when mismanaged. Fortunately, this is a story about how it can go right.
At the beginning of 2020, my company, Quantum Metric, was on a tremendous growth curve. We couldn’t have been more excited — and then COVID hit. Suddenly, everything was up in the air. Customer behavior quickly began to reflect the uncertainty we all felt, and my team wasn’t immune to it, either. Like most, we sweated through the first few months of the pandemic.
If companies want to preserve equity, debt can be an advantageous choice.
On the one hand, we felt it might be our time to shine, as digital solutions rose to the surface even in industries that were previously slow to adopt them (think banking and airlines). On the other, companies were trying to lock up as much cash as they could, as fast as they could. What if our customers weren’t able to pay us?
One thing became crystal clear: We needed cash, too. First and foremost, we needed it to protect the company against the income loss we anticipated from customers who were having an especially tough time — namely, those who relied on in-person business as a major revenue source.
Second, we needed cash in order to scale. As the weeks following the initial shelter-in-place orders ticked by, the rush toward digital grew exponentially, and opportunities to secure new customers started piling up. A solution to our money problems, perhaps? Not so fast — it was a classic case of needing to spend in order to make.
Most startups face this dilemma at some point. Some face it continuously. We needed a way to funnel capital into growth and manage to stay cash strong, which was important for another reason: As we headed downstream toward a Series B funding round, we were hesitant to devalue the company (and employee shares) any more than was absolutely necessary.
“There are no solutions, there are only trade-offs,” Thomas Sowell wrote about politics. It’s no different in business. We knew that for Quantum Metric to succeed, we had to give up something in the future in order to get what we needed in the short term. Choosing a debt round as a younger company ran the risk of cash-flow misalignment down the road, but in the same vein, an equity round might have made subsequent funding rounds more challenging.
Whatever we did, we had to do fast, and we had to do it in a chaotic venture capital environment (that may be an understatement). In some meetings, it felt as if VC money had dried up completely. In others, record deals were being made. Startups were bypassing IPOs and going public via SPACs and direct listings. Factoring in the amount of hype that was permeating the market (something I’ve never been a fan of), the “wise” decision felt elusive. As you know from the headline of this piece, though, we chose debt, and it paid off.
The benefits of choosing debt over equity
There ended up being two “layers” of benefits to our debt round. The benefits of the first layer correspond directly with the goals I mentioned above; we got the cash we needed in order to expand — which meant investing in our team, product, marketing and infrastructure — and avoided diluting the company’s value for existing shareholders in the process.
The second layer of benefits came as a result of the first, which we couldn’t have really predicted. By quickly expanding and helping enterprises bridge crucial gaps in their transition to digital, we found ourselves experiencing a quantum leap (pardon the pun) in word-of-mouth marketing from our customers.
They spoke so highly of us and our product (something we can’t thank them enough for) that Tier 1 investors were inbounding on a weekly basis. Not only did we not have to shop a Series B funding round, we didn’t even need to create an investment deck. This was a huge win, and it put us squarely in the driver’s seat, allowing us to be extremely selective about when and with whom we would form new financial partnerships. A few months later, this led to a $200 million investment that put us over the top into unicorn status.
But can your company do the same?
It is not lost on us that for many early startups, debt financing is not an option. It’s not always about willingness to take on debt; it’s also about being able to. In most cases, it requires collateral, a guaranteed income stream (or risky contractual agreement), and patient investors. And given that equity funding is relatively abundant, most founders are happy with that method of securing capital. If companies want to preserve equity, however, debt can be an advantageous choice. For us, two other factors helped make it possible.
Right product, right time
COVID brought countless negatives with it, but there have been a few positives, too. It acted as a cross-industry catalyst in a way that allowed us to dial in our product-to-market fit at just the right moment in our company’s journey. Clearly, luck played a role here.
At the same time, the momentum we gained during the pandemic was a result of our positioning beforehand. If there’s a takeaway for other entrepreneurs or businesses, it’s to believe in your product even if it feels ahead of its time. Just because you have not yet caught the wave of market trends does not mean you do not have the capability to meet customer needs — unless, of course, you give up.
Existing income
Plenty of startups don’t even get their first paying customers until they’ve hit Series C or D funding. Having several considerable contracts under the company’s belt early on significantly affected how confident we were about having debt in the portfolio. (In truth, most debt-based investments aren’t available at all for pre-revenue companies.)
It might sound obvious to lock down a revenue stream as early as you can, but it also contradicts what many businesses do. The important thing is to consider what’s right for your company, and not necessarily what others (including me) tell you.
We couldn’t be any happier with the results of opting for a debt round. Since then, we became one of 2021’s first billion-dollar companies, made some fantastic additions to our team and advisory board, were featured in a Gartner report that named us a “digital leader in technology,” and achieved an extraordinary customer retention rate. That said, the message isn’t just that we and our product are awesome (even if we think that), and neither is it that you should consider debt financing as an ideal path to growth.
Instead, the message is about the value of unorthodox strategies, especially in uncertain times. Surround yourself with people who have integrity and a passion for your product, then trust them when the going gets tough, even (or especially) when their suggestions are outside the box. In my experience, when you have these pieces in place, just about everything else will take care of itself.