Over the last several years, venture debt financing has grown in popularity among high-growth companies as a minimally dilutive form of growth capital. Available to both non-equity and equity-backed businesses, venture debt requires no board seats, no personal guarantees, and involves minimal equity.
Best used for companies in the growth stage, traditional venture debt loans generally resemble a term loan with monthly interest payments and can last up to three years. Another form of venture debt is revenue-based financing, which takes a percentage of monthly revenue as opposed to a fixed interest rate.
This article will describe seven popular uses of venture debt.
Cash runway is the amount of time your business can operate before running out of money.
Investors recommend a cash runway of 18-24 months between funding rounds. The best way to calculate your own company’s ideal cash runway is by predicting your financial needs from the start, raising cash accordingly, and minimizing expenditures where you can.
Venture debt financing was developed to meet the needs and the perceived risks associated with tech companies. Raising venture debt allows you to extend your cash runway while minimizing equity dilution and maintaining control of your company. The cost of venture debt is far less expensive than raising another round of equity.
One of the most classic use cases for debt loans is funding large capital expenditures, such as purchasing equipment or acquiring smaller or complement companies.
While large capital expenditures are much less common for companies in industries such as cloud-based software, it does allow companies to make large purchases without depleting the company’s cash balance or going through a round of equity and consequent dilution.
A bridge round is a small round of funding to hold the company over, acting as a ‘bridge’ between the company’s current liquidity needs and its next funding round.
Bridge rounds are strongly associated with risks, mainly because raising a bridge round begs the question of where all the company’s previously-raised money went. Doubts are raised in investors’ minds about the ability of the C-suite to manage their money well. If any lead or current investors tap out of a bridge round, this signals to outsiders that current investors are having second thoughts about backing the company.
Although raising a bridge round can be done quickly, it can be expensive and comes with signalling risk. Instead, venture debt provides no signalling risk, it frees up the full amount of equity to be raised fresh at the round, and it doe snot require a valuation.
A valuation determines the present value of a company using a variety of factors such as financial projections, the market value of the company’s assets, its capital structure composition, and the management of the business.
There are times when a company may be underperforming, whether from internal factors or external factors such as market conditions changing. This may cause concern that the next round of capital will result in a down round, where pre-money valuation of a funding round is lower than the post-money valuation of the previous round.
Venture debt allows businesses to raise growth capital without having to set a valuation. Instead, it provides the capital you need to fund growth initiatives and achieve milestones so that your company is in a better position for valuation at the next equity round.
Each funding round is designed to get a company to its next funding round, so equity investors will look at how much cash the company is forecasted to burn to reach the next milestone.
Venture debt provides an extra cushion in the event a company needs more time to get to that next milestone. In fact, many companies choose to raise venture debt alongside an equity raise for peace of mind in knowing that it has enough operating cash to get through an unexpected period of low revenue.
Companies on the cusp of break even may look for an extra boost of capital to get them over the line. Management and current investors may find less dilutive financing options more attractive at this stage of the company’s life.
Venture debt is a great option for companies that are nearly break even because it is minimally dilutive and can completely eliminate the need for a final round of equity financing. There are also more repayment options available, such as a longer amortization term. Longer amortization makes more sense for a company close to profitability as the company has more time to repay the loan when they are cash flow positive.
