In our previous article, we discussed the importance of creating a debt stack to help scale your business. While understanding the use cases for each type of financing is key, it’s even more critical to know which types of debt your business is eligible for. Eligibility is usually based on factors like your sales channels, customer base, profitability, and other key criteria lenders use to assess your qualifications for funding.
When does debt become an option?
In the F&B space, where venture investment is limited, debt has emerged as one of the most consistent and reliable ways for founders to grow their businesses. But it’s important to note that debt usually isn’t available to get your business off the ground. Lenders, across all categories, usually require a history of sales, or other positive financial factors like projections or passive income to assess whether you’ll be able to repay the loan.
When starting a business, there are two primary ways to raise the funds needed to launch your product: bootstrapping or raising equity. The approach you choose will depend largely on your financial situation and access to potential investors. As you build your business plan, one of your key goals should be to generate enough sales to qualify for debt financing. This approach lets you reduce reliance on personal income or giving up equity to fuel your business growth.
What debt to look for
As your business moves into its growth stage, debt financing becomes a powerful tool to fuel expansion. At this stage, you’ll want to explore debt options that align with your cash flow, business model, and growth plans.
Cash-flow lenders:
Term loans and Lines of Credit lenders offer your business cash flow flexibility and allow you to invest the money as you see fit.
Quick Tip: Always invest debt capital in revenue-generating expense categories.
Products Overview:
- Term Loans: Term loans are ideal for major, long-term investments like purchasing real estate, machinery, or expanding your business. These loans provide a lump sum upfront, which you repay with interest over a set period. The clear repayment structure and fixed terms make it a great choice for larger, planned expenses.
- Best for: Increasing cash on hand, business expansion, or any substantial investment that needs a clear repayment plan.
- Lines of Credit: A line of credit works like a revolving credit account, giving you access to funds when you need them without requiring immediate use. This is great for covering short-term cash flow gaps, seasonal fluctuations, or unplanned expenses. You only pay interest on the amount you borrow, and once repaid, the funds are available again. It’s like a credit card, but usually with better rates and larger available credit.
- Best for: Managing seasonal cash flow, covering unexpected expenses, or maintaining operational flexibility.
What Cash-Flow Lenders Look For
When it comes to cash-flow lending, lenders focus on one key number: your debt coverage ratio (DCR). This ratio shows how much cash flow your business has to cover its debt payments. In simple terms, it checks if your revenue is greater than your liabilities—it basically tells lenders if your business is profitable.
While DCR is the main factor, lenders also consider other financial aspects. For example, if your business has raised equity or you have personal income streams, these give you extra cash on hand and a longer financial runway. Lenders often take this into account during the underwriting process, which can provide more flexibility.
Lenders also look at how long you’ve been in business and your credit score. Most SBA lenders require at least 2 years of revenue generation and a minimum credit score of 640.
Quick Tip: If your credit score is lower than that, check out this article to help founders improve it.
While most lenders follow standard guidelines, there are exceptions.
Community Development Financial Institutions (CDFIs), for example, often offer SBA-backed and internal term loan products that are more accessible to earlier stage businesses. Instead of strict requirements, they tend to focus more on your business projections and current growth trends.
Transactional lenders:
On the other side of debt financing, often working alongside cash flow products, are transactional lenders. These lenders specialize in financing your supply chain, offering solutions like purchase order financing, factoring, and asset-based or inventory loans.
You can leverage these tactical loan products for specific use cases like adding inventory, fulfilling wholesale orders, and unlocking accounts receivable, so you don’t need to spend too much out of pocket and wait too long to get paid as you scale up. Keep in mind that you can have a good debt stack with any or all of these solutions in place.
Products Overview:
- Inventory Financing: When your purchase order timelines or customer demand require you to maintain a higher volume of inventory on hand, inventory financing helps ensure you don’t need to lay out a large amount of cash to avoid delays in fulfillment. In a debt stack, a business can use inventory financing up to the point of receiving a PO, and then use PO Financing to repay the liability at a better rate.
- Best for: Companies that take longer to produce inventory than their wholesale purchase orders allow for, meaning they need to buy inventory ahead of receiving a PO, or businesses with high omnichannel sales who need to stock up for both ecommerce and wholesale.
- Purchase Order (PO) Financing: When your business has a confirmed order but lacks the capital to fulfill it, PO financing can help bridge the gap. The lender covers most or all of your cost of goods, allowing you to deliver on customer orders without straining your cash reserves. Then, once the order is fulfilled, you can use AR financing to get an advance on the customer payment (and many lenders offer both of these products, simply reducing the monthly rate at invoice issuance).
- Best for: Companies that need upfront capital to fulfill large customer orders.
- Accounts Receivable (AR) Factoring: If your business is waiting on customer payments but needs cash now, AR financing lets you borrow against your outstanding invoices. It’s a great way to smooth out cash flow without waiting for invoices to be paid.
- Best for: Businesses with long payment cycles looking to access cash tied up in receivables.
There are two types of Accounts Receivable Factoring:
- Non-recourse factoring is a type of financing where a business sells its accounts receivable to a factoring company, and the factor assumes the risk of non-payment by the customer. If the customer does not pay, the factor absorbs the loss, meaning the business is not liable for bad debts.
- Recourse factoring is when a business sells its accounts receivable to a factoring company but retains the risk if the customer fails to pay. In this case, if the customer defaults, the business must repay the factor or replace the invoice with another receivable.
What Transactional Lenders Look For
Transactional lenders primarily look at who your customers are rather than your business itself. That’s why they can be a good option for businesses that aren’t profitable yet but need cash-flow financing.
When they look at your application, they’ll mainly look at how trustworthy your customers are and how solid your track record of sales—specifically, how reliable your customers are at paying on time. While time in business and revenue can sometimes be factors, most lenders require at least $100K in purchase orders to offer a credit facility.
Next Steps
Before using debt as a growth tool, it’s important to step back and see if it’s the right choice for the stage your business is in. For startups, options are often limited because of lender criteria and eligibility requirements. In this early phase, access to capital will typically rely on revenue from sales, bootstrapping, and investors.
As your business enters the growth stage, things change. Building a thoughtfully constructed debt stack becomes more than just a financing strategy. It helps businesses manage risk, optimize their capital structure, and position themselves for long-term success in a competitive industry.
Don’t know where to start? Book a free consultation call with Bags here to learn more and start unlocking dollars to grow your business.