Borrowed money makes a good race twice as sweet. It makes a crash twice as painful, and the interest is due either way. This week you put numbers on both sides.
Learning objectives. After this week you can (1) compare debt and equity financing; (2) compute a debt-to-equity ratio; and (3) compute burn rate and runway.
Remember this: leverage magnifies gains and losses alike. Runway tells you how long you can last.
1) Debt vs. equity
- Debt financing: borrowing that must be repaid with interest. You keep ownership but owe fixed payments.
- Equity financing: selling ownership stakes. Nothing to repay, but you share the upside.
The cost of debt is the interest rate you pay. A $100,000 loan at 8% costs $8,000 a year.
2) Leverage
Leverage is using borrowed money to make a bet bigger. One common gauge:
Debt-to-Equity = Total Debt ÷ Equity
$200,000 of debt on $100,000 of equity is a ratio of 2.0: two borrowed dollars for every dollar of your own. Higher leverage means more financial risk.
3) Burn rate and runway
Runway = Cash ÷ Burn Rate
Burn rate is how fast you spend cash. A startup with $60,000 burning $15,000 a month has a runway of 4 months. For your team the period is the race week: a $40M bank spending $8M a race has 40 ÷ 8 = 5 race weeks of runway, before any Winnings come in.
4) Credit ratings and default
A credit rating is your borrowing reputation. A higher rating earns a lower interest rate. More debt relative to income looks riskier and raises the rate. Collateral is an asset pledged to back a loan. Default, failing to repay as promised, lowers the rating.
Quick self-check
(a) Cash $90,000, burn $30,000 a month: runway? (b) Debt $300,000, equity $150,000: debt-to-equity? (c) A $50,000 loan at 6%: yearly interest? (Answers: 3 months; 2.0; $3,000.)
Common mistakes
- Flipping runway. It is cash divided by burn, not burn divided by cash.
- Counting only the upside. Leverage doubles a bad week just as surely as a good one.
- Forgetting interest on a loss. Interest is owed whether you finish first or last.
This week in the arena
Your burn and runway are real numbers. Burn is what you plan to spend this race week; runway is your bank divided by that. Work them out before you save a budget. Then picture half of that spend as an 8% loan: what would your debt-to-equity be?