Welcome to TEXAS BUSINESS FINANCE
What Is Venture Debt?
Alternatives For Business Owners
The Early Days
There are narrow and broad definitions of venture debt. The term “venture debt” or “venture lending” was originally used in the 1970’s to refer to equipment financing (venture loans and venture leasing) provided to early-stage companies. These startups needed to acquire physical assets, such as computer hardware or life sciences laboratory equipment, but lacked the cash flow for traditional debt financing.
The Emergence of Venture Banks
In the early 1980’s, lenders such as Silicon Valley Bank (SVB) created a new type of venture debt financing. Generally, they did not require physical assets nor cash flow. However, they focused on providing loans to startups backed by well-known venture capital firms. The loans were structured to complement the equity provided by the venture capital firms, and were essentially secured by the enterprise value of the startup and the expectation that the venture capital investors would continue to fund the startup in subsequent equity rounds.
The Proliferation of Lenders
During the low-interest rate environment since the Great Recession of 2007-2009, institutional investors have been aggressively seeking out higher yield lending opportunities. Venture debt caught their attention, which has led to a tremendous increase in the number of lenders and types of loans in the market.
This expansion has been so broad that the term “venture debt” and its common definitions are much too narrow. As a result, some industry participants and observers have begun to use the term “growth debt” instead of “venture debt.”
At Find Venture Debt, we agree that “growth debt” has become a more appropriate term as the market has evolved. However, we continue to use “venture debt” as an umbrella term for a broad range of non-dilutive and minimally-dilutive funding since it’s more commonly recognized.
the Benefits and DrawBacks of Venture Debt Financing
- Accelerate growth: Provides growth capital while avoiding or minimizing equity dilution.
- Extend cash runway: Provides a bridge between equity financing rounds, allowing a company to achieve key milestones and a higher valuation in the next equity round. Can also extend the cash runway until profitability, allowing them to avoid raising additional equity or reach the point at which less expensive capital is available.
- Prepare for Series A round: A startup that has not completed a Series A equity round may benefit from first raising venture debt. A partnership with an experienced debt investor can accelerate growth while helping management refine strategy and improve operations. These actions should enhance the appeal to venture capital investors and maximize valuation in the subsequent Series A equity round.
- Easier to obtain than bank debt: Does not require positive cash flow or significant assets to use as collateral.
- Alternative to raising equity from VC firm: Can be a great alternative when a business needs growth capital but is not growing fast enough to attract a venture capital firm or is not satisfied with the terms offered.
- Alternative to selling to PE firm: For late-stage companies, can be a great alternative when a business needs growth capital but does not want to sell a controlling interest or is not large or profitable enough to attract a private equity firm.
- Flexible terms: Less restrictive than banks with regard to amount borrowed, term, amortization, covenants, and personal guarantees.
- No loss of control: Generally, lenders will not require board seats or other direct involvement in the governance or operations.
- Quick process: Can be as short as 30 days versus 3-6 months for equity, primarily due to a simpler and faster due diligence process.
- Does not require sponsorship by PE or VC firm: Although some lenders require that borrowers have VC or PE investors, it is not a universal rule. There are many who will consider both sponsored and non-sponsored companies.
What are the Drawbacks?
- Debt must be repaid: The borrower must make scheduled principal and interest payments.
- Equity participation: Depending on the type of debt, the lender may require equity participation.
- Difficult to estimate the cost of capital: Due to amortization, equity participation, and other features, it can be difficult to estimate the cost of capital.
Deal structure and client profile
Deal Structure
- Loan size: up to $5,000,000 - $500,000 - $5,000,000 strike zone
- Senior and Subordinated (“2nd Lien”)
- Term: 9-36 months
- Pricing contingent on credit profile
- Flexible repayment structure, but amortization required
- Covenant light
- Underwrite based on cash flow
- Secure with available collateral (corporate assets and personal guarantees)
Client Profiles A and B
- Broad industry coverage (no restrictions) •
- Client A Revenue: $10,000,000 - $100,000,000+ Client B Revenues $1,000,0000+
- Cash flow to support amortization
- Private companies and public companies
- Geography: United States
- Broad Use of Funds