Weathering the Storm with Venture Debt
Uncertainty looms over the heads of VCs as the COVID-19 pandemic, economic crisis, 2020 Presidential Elections, and de-globalization force the brakes on the industry. Due diligence and discussions have come to a halt, and VCs are shifting their priorities inwards and are triaging their existing portfolio. For startups, this means trying to stay funded past this initial phase, and venture debt rises as an increasingly attractive source of capital.
Why Venture Debt?
Minimally-Dilutive
The main advantage venture debt has over traditional equity financing is that it is minimally-dilutive. Venture debt is typically structured as a term loan with terms usually lasting up to three years. Oftentimes venture debt providers will take warrants. Dilution from warrants is typically limited to 1–2%.
Warrants give the option to subscribe to a predefined amount of a company’s new equity at an exit event. The price at which the options are exercised are agreed at the time of underwriting the facility and is usually linked to the most recent equity round.
Streamlined Process
The process of raising venture debt is significantly more streamlined compared to other forms of financing. Unlike equity rounds, venture debt providers do not require company valuations and the due diligence process is relatively less stringent.
Increase Company Valuations
Similar to bridge loans, venture debt offers entrepreneurs the opportunity to fund growth initiatives to reach critical milestones and get to the next round of funding at a higher valuation.
When to Take Venture Debt?
To Extend Cash Runway
Each round of equity is designed to get the business to its next funding round. Investors place tangible milestones they expect the company to achieve during this timeframe, providing evidence to new investors the company has progressed, is on track, and is less risky than at prior rounds of funding. In the event the company takes longer to get to its milestone, venture debt can help extend the cash runway of the business without increasing dilution and at a much lower cost than pursuing a bridge round.
Prevent a Bridge Round
A bridge round is a form of borrowing against the next equity raise, usually in the form of a convertible note and warrants. Bridge rounds can be done quickly and push out pricing until the full equity round. However, bridge rounds can be expensive and could signal to new investors the company did not hit its target in the time planned — raising a red flag. Instead, venture debt can eliminate that signaling risk and frees up the full amount of equity to be raised fresh. Lastly, venture debt does not set valuations, so the founders and management team can benefit from a higher valuation at the time of the new round.
The Insurance Policy
Venture debt can provide an extra cushion in the event that a company needs more time to get to its next milestone. This is especially useful during times of uncertainty when volatility remains an issue.
Large Capital Expenditures
Making large purchases is a normal part of growing a business. Venture debt allows companies to use the proceeds of the loan to make these purchases without depleting the company’s cash balance or going through a round of equity and consequent dilution.
Acts as a Bridge to Profitability
Companies on the cust of breakeven can completely eliminate the need for a final round of equity simply by using venture debt. Venture debt acts as a bridge to profitability, propelling the company forward during a critical period of growth.
Article Written by: Sabena Quan-Hin
