Venture Debt Uses – Avoid Setting a Valuation
A valuation is the process of determining the present value of a company using a number of techniques, such as looking at financial projections, the market value of the company’s assets, its capital structure composition, and the management of the business. An objective valuation is typically needed when negotiating with banks or other potential investors for funding.
Let’s say a company is experiencing good performance but is having difficulty in raising capital on terms that reflect that performance. Growth may have slowed down compared to previous periods or perhaps the prior round was set at a high valuation. Current investors may use this to have a down round term sheet on the table.
A down round occurs when the pre-money valuation of a fundraising round is lower than the post-money valuation of the previous round. In such cases, it is a difficult situation for new investors to step into. The new investor will need to clearly understand board dynamics and confirm management and the board agree on the company’s direction. If that’s the case, the company may benefit from a venture debt loan where the lender has comfort the enterprise value is sufficient to cover the loan despite a period of low growth.
Venture debt is useful for companies faced with a down round as it can help put off an equity raise until its valuation increases again.