Stage 3 · Choose and negotiate financing · Lesson 1 of 6
Loan, equity, mezzanine, grant: which one is for you, and what the words mean
At the “Funding” step of your file, two answers decide who will read it: the form of the money and the amount. This lesson helps you choose the form from what the money will pay for, then translates the words you will hear in meetings.
The question on the phone
A fund’s first call often starts with “debt or equity?”
A maker of compressed earth bricks in Antsirabe, with seven staff and two presses. We will call him Tahina; he is a composite of several files. He needs 80,000 dollars for a third press and a stock of cement.
A Mauritian fund calls and asks whether he is looking for debt or equity. He answers “both, or whatever you have”. It is an answer funds hear often. The fund does not call back.
The project was not the problem. This fund buys shares in companies that want to grow fast, from several hundred thousand dollars upwards. A press that pays for itself with the bricks it makes is outside its mandate. And the answer suggested Tahina had not decided what he was asking for.
Three forms and their mixes
Money is paid back, shared or given. Everything else mixes these three.
Your file’s form offers “Debt / Loan”, “Partnership / Co-shareholder”, “Mezzanine loan”, “Grant / Donation” and “To be defined with our team”. Behind those boxes are three simple forms.
- Principal and interest, on fixed dates, even in difficult months
- Security: land, a machine, a personal guarantee
- The lender shares neither your losses nor your gains
- Nothing to repay each month
- The investor holds a share until they sell it, usually 5 to 7 years for a fund
- A fund targets about 15 to 20% a year in dollars, earned when it sells
- No repayment and no share of the business
- Conditions, reports, often part of the budget to fund yourself
- A slow answer
Fund return target: British International Investment, 2024, set out in the lesson “What each kind of money costs”. Exit horizon: usually 5 to 7 years, depending on the fund.
Two mixes come up often. Mezzanine is a loan repaid after the bank (it is called subordinated). It usually costs 2 to 3 points more than a secured bank loan. Often there is also a small share of sales or an option on shares, known as the kicker.
Revenue-based financing is repaid with 2 to 10% of each month’s sales, until you have paid back 1.5 to 2 times the sum received. It asks for no shares and no security, but it needs regular sales. In the form, these mixes come under “Mezzanine loan”.
- Choosing in four questions
- Who funds, from how much
- Your amount, your counterpart
- What you give up
- Money that does not fit the need
- The words of the meeting
- In your file
- One sentence, one action
The rest of the lesson
Keep reading with your free account
8 more parts, with the calculations on your own numbers and what to write in your file. The account is free, no commitment.
The words of this lesson
Each word links to its full definition in the glossary.
- Dilution
- Your share of the company gets smaller when a partner comes in. The cake grows: your slice can be worth more.
- Mezzanine
- A loan dearer than a bank loan, repaid after the bank. The lender often also asks for a small share of the company.
- DSCR
- What you earn, divided by what you must repay this year.
- Covenant
- A number you promise in the loan contract and must hold to every year.
- Term sheet
- A short letter, before the contract, summarising the investor’s offer: amount, share, conditions.
- Additionality
- Proof that a public institution brings something an ordinary bank would not.
- Equity
- An investor becomes your partner by buying a share of the company. Nothing to repay; they gain if the company is worth more later.
- Loan
- Money is lent to you, you repay it with interest, and you keep 100% of your company.
- Grant
- Money you do not repay and that costs you no share of the company.
- Quasi-equity
- Money that behaves like a loan at first and can turn into share capital later.
- SAFE, convertible note
- An investment now, with the exact share worked out at the next round.
- Kicker
- The option on shares a mezzanine lender adds to the loan, to capture some of the upside.
- Revenue-based financing
- You repay a fixed percentage of monthly revenue, up to a cap.
- Blended finance
- Public or philanthropic money placed ahead of private money, to absorb the first losses.
From the lesson to your file
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