Venture Debt Pros & Cons to Help Weigh Your Funding Options
If you’re an entrepreneur, you know about venture capital and how it can play a vital role in funding your early-stage company if it has the requisite maturity. Fewer folks are familiar with the concept of “venture debt.” While it may not be as prominent as its capital cousin, venture debt is a financing option young companies should at least consider alongside equity investments as they seek additional resources to grow and scale.
What is Venture Debt?
Venture debt is a form of financing for companies which may lack the assets or cash flow sufficient for traditional debt financing. It usually takes the form of a non-convertible, senior term loan that can be used like equity and is paid back in monthly installments over the life of the loan, which typically ranges from three to four years. Venture debt can also take the form of an equipment lease.
Offered by banks as well as dedicated venture debt funds, these loans typically include warrants, which give the lenders the right to buy stock. Most venture debt is taken on in conjunction with or after a round of more traditional venture capital financing.
Why Consider Venture Debt for Your Company?
According to PitchBook, the total cumulative value of start-up deals completed in 2013 that were at least partially composed of debt was $4.3 billion. By 2016, that number had skyrocketed to $14 billion.
There are many reasons for the increased presence of venture debt in the start-up financing ecosystem. Three of the most compelling reasons for considering venture debt for your company are:
- Less equity dilution. The big trade-off with venture capital financing is that the money usually comes in exchange for a significant amount of the founders’ and shareholders’ equity interests. When companies are seeking a subsequent round of financing after already relinquishing control of some of their equity, parting with even more can be that much more painful. Venture debt transactions result in far less equity dilution than do traditional capital investment.
- Less due diligence required. Banks and other venture debt lenders loan to startups that already have access to the pockets of institutional investors, like venture capital firms. These equity investors have already thrown their chips in with the company and did so only after extensive due diligence. That, combined with the likelihood that institutional investors may provide additional capital down the road, gives venture debt lenders the security they need to fund their loans. Not that they won’t take a look under the hood.
- Flexibility and a longer runway. Companies usually face fewer operational restrictions with debt funding, and the way venture debt is structured can give companies a longer runway to reach certain milestones or until the company is cash flow positive.
Venture debt financing has its risks
Of course, no debt comes without potential downsides and risk. Whether venture debt is right for your company depends on your specific circumstances and goals. If you would like to learn more about venture debt or other financing options for your start-up, please contact us.