Many start-ups share a common characteristic: during their growth phase, they spend more money than they generate and are expected to become highly profitable in the long term. These cash flow dynamics create an obvious need for financing and raise the question of which funding approach is best suited to meeting a company’s capital requirements.
There is no simple answer. However, factors such as timing, risk, and founder value creation are key considerations in any well-designed funding strategy for a start-up.
Timing encompasses a number of important considerations. All else being equal, it is preferable to capture the proverbial pot of gold at the end of the rainbow today rather than tomorrow. Venture-backed start-ups typically operate with business models that have an exponential growth component, making it possible to rapidly scale and generate significant margins on products or services. Timing is also about entering the market before competitors and thereby securing a critical opportunity to differentiate. New tools for software development, operations, and maintenance—not just AI-related tools—have made development cycles and scaling significantly easier than in the past. As a result, competitors can now launch similar products much faster. Time has therefore become an important competitive moat, helping to protect a business until more durable barriers to entry can be established.
Risk concerns both the risk of running out of funding and the risk that an uncontrolled need for capital may undermine a founder’s control of the company and ability to focus on building and operating the business. Unfortunately, I have seen too many examples where the pursuit of funding distracts founders from running their companies effectively.
Last but not least, funding decisions are fundamentally about value creation for founders and existing shareholders. The financing structure should maximize the value of the founder’s equity. This should not be confused with simply maximizing ownership percentage. A smaller stake in a more valuable company can be worth significantly more than full ownership of a less successful one. Put differently, it is generally better to own 25% of a company worth EUR 100 million than 100% of a company worth EUR 10 million.
These considerations leave founders with at least three broad financing options, which I will briefly outline below. In practice, most financing strategies involve some combination of these approaches, but they differ considerably in their characteristics.
The first option is self-financing, meaning that the company funds its growth through its own revenue generation. As noted above, this is rarely feasible for a venture-backed start-up. Nevertheless, bootstrapping generally results in a lower risk profile and clearly reduces the risk of founder dilution. The trade-off is that it often comes at the expense of speed, market timing, and, in many cases, ultimate value creation for the founder upon exit.
The traditional funding route is equity financing, where investors subscribe for newly issued shares. This is by far the most common form of financing for start-ups, primarily because investing in start-ups involves substantial risk and therefore requires the potential for substantial returns. Investors expect to realize these returns through the value of their shareholdings upon exit, rather than through a predetermined return such as interest payments.
From the company's perspective, equity financing is generally less risky. There is no requirement for ongoing repayments or fixed returns independent of the company's performance. In a downside scenario, a company is typically better protected when funded by equity investors. However, this also highlights one of the drawbacks of equity financing: investment terms often allocate a disproportionate share of downside risk to founders. In addition, founders inevitably experience ownership dilution, although not necessarily a reduction in the value of their holdings.
Equity investors generally require significantly more influence over the business than lenders. They tend to impose more extensive investment terms and conduct more comprehensive due diligence in order to assess risk. As a result, equity financing is often much more legally and commercially complex, making it difficult for founders to fully assess the long-term implications of the arrangements they enter into.
Finally, start-ups may seek financing through debt. Financing a venture-backed start-up with debt is inherently challenging because lenders can only price risk through the return they receive, and there are both regulatory and commercial limits to the interest rates that can realistically be charged. It should be noted that lenders can be compensated in other ways as well. For example, they may receive an exit-related bonus based on the value of the company’s shares or be granted the right to convert their loans into equity.
The obvious advantage of debt financing is that it does not dilute existing shareholders. Instead, the cost is limited to the agreed interest and other financing terms. If a company’s value increases by 50% annually, an interest rate of 10% can be a relatively inexpensive source of capital.
The downside, from the company’s perspective, is that interest payments must generally be made regardless of business performance and that the principal amount must ultimately be repaid. This stands in contrast to equity investors, who share the risks and rewards of the business alongside the other shareholders.
Although debt financing can be difficult to obtain, it is my experience that founders often underestimate how cost-effective this funding source can be. This is partly because there are relatively few private providers of debt financing focused on the start-up market. However, within the scale-up segment, firms such as Gilion have gained increasing traction in the Danish market. Likewise, EIFO can be a valuable financing partner, particularly when equity investors are involved and are willing to share risk while contributing an independent market-based assessment of the company’s prospects.
A possible takeaway from this overview is that founders should carefully consider their need for speed, risk management, and value preservation when choosing a financing strategy. It is also worth remembering that debt financing, despite often being overlooked, should almost always be part of the funding discussion.