Demystifying Venture Debt
Venture debt is an important source of capital for startups, yet there’s relatively little information about the funding option out there. Very often, lenders know more about the process than VCs and founders. We’ve put together a short summary of venture debt below to help shed some light on the process for founders.
By definition, venture debt is a type of debt financing provided mainly to venture backed companies by specialised lenders, to fund working capital, runway, growth projections, M&A and more.
The alternative capital scene has attracted significant attention recently. This is down to a few factors, but notably, companies are choosing to stay private for longer. Venture debt provides a way to avoid down rounds, dilution, and unfavourable terms.
A mix of debt and equity is becoming a more popular option for companies looking to secure funding. For instance, corporate management startup, Ramp, recently confirmed that it’s secured $550 million in debt and $200 million in equity, doubling valuation to $8.1 billion.
Originating in the US in the early 90’s, venture debt has changed quite significantly over the years. Most commonly known for being money before or with an equity round, venture debt often had significant equity warrants and aggressive repayment profiles.
Today, venture debt is used more as an umbrella term, and it can take many forms. However, there are still many common misconceptions about this alternative financing option, leading to people overlooking the benefits that debt can offer.
Many believe venture debt is available exclusively for profitable companies. This is false; many companies suitable for venture debt are cash intensive, loss making businesses choosing to reinvest in the business to acquire market shares or investing in their intellectual property, software and people.
Secondly, people are often of the view that venture debt only comes with aggressive warrants and restrictive covenants, and that they’ll have to give away a fair share of their company to access this source of capital. While this used to be the case, some funds now don’t take warrants at all, and many funds will provide solutions with zero covenants attached. It’s all about finding the right option for your situation.
The benefits of venture debt extend to both VCs and founders. It is a non-dilutive option, cheaper than equity, flexible and tailored to your needs, and involves rapid execution. It also typically constitutes a mezzanine finance option to compliment equity raise options, providing a very efficient cost of capital.
For VCs, venture debt allows you to leverage investments, adding firepower to the table without increasing exposure. For companies, the most attractive benefit of venture debt is that it provides funding without dilution.
When executed in the right way for the right type of company, the key benefits of venture debt are:
Extends Cash Runway — Venture debt can complement your capital structure.
Enhances Growth Potential — In specific scenarios, debt can be used to extend your runway outside of any equity events. Your customers, clients, long term contracts and intellectual property can be perceived as great assets by lenders.
Provides Efficient Cost of Capital — For a fast growing business, cost of capital is an important consideration. If your business is growing at an annualised rate greater than cost of lending, then debt can work out cheaper than equity dilution.
When looking to grow your business, it’s important to consider all the options available to you. With the right support and guidance behind you through the help of an advisor, the venture debt process is surprisingly simple.