Venture debt is a non-dilutive investment structure for high-growth businesses.
This form of financing is typically used by companies with annual revenues above $1 million and a business model that facilitates growth potential. Provided by banks or alternative financing companies, venture debt acts as an alternative or complement to equity financing. Although it creates a cash expense for the company each quarter, it comes with less dilution than equity financing and does not require a business valuation.
Venture debt enables businesses to reach their growth objectives while maintaining control and equity.
It is a form of debt financing for venture equity-backed companies that lack the assets or cash flow for traditional debt financing or for those who want greater flexibility. As a complement to equity financing, it is typically structured as a 2 to 3-year loan with warrants for company stock. Venture debt is generally considered senior debt that is secured by a company’s assets. In comparison to equity financing, venture debt is “risk capital” that is less costly when structured appropriately. It is also a great option for non-venture backed companies who want to maintain control and equity, that would otherwise be lost through equity financing.
Venture debt lends itself to a number of growth strategies, including but not limited to:
There are 5 common use cases for instances where venture debt can be used:
1. Extending Cash Runway
Receive an extra boost in cash in order to hit your next milestone without increasing dilution.
2. Preventing Bridge Round
Raising a bridge round from existing investors is expensive and sends a negative signal to prospective investors.
3. Funding Large Capital Expenses, Acquisitions, or a Bridge
A cheaper alternative to equity to fund larger expenses or to fund new growth initiatives that require an amount of capital too small for an equity round.
4. Insurance Policy
Acts as an insurance policy in case it takes longer than expected to hit the next milestone.
5. Funding to Profitability
Achieve profitability without incurring additional dilution from equity.
If you don’t think you can repay the debt or raise more equity.
If the terms or covenants are too heavy/difficult.
If your venture investors are not supportive.
Founders should ensure their business is able to generate enough cash to service debt repayments.
With loan sizes typically between $1M and $5M, companies considering venture debt as a potential solution for growth capital should ensure their business is able to generate enough cash to service debt repayments or that there is a clear path to a future funding round.
Companies must be able to show strong growth momentum.
In contrast to debt or equity financing, venture debt protects the equity of existing shareholders, provides a lower cost of capital, and delivers a faster funding process. When meeting with investors, it is important to show strong growth momentum. Growth capital lenders look at future growth potential rather than past performance. Therefore, businesses that apply for this form of financing should develop clean and realistic financial forecasts that include a fully funded business plan, achievable forecasts, and clean assumptions on funding, KPIs, cost structures, revenue build-up, and working capital dynamics.
In order to increase the attractiveness to venture debt lenders, companies should highlight scaling opportunities, indicating the business model is proven and requires additional resources to grow. Companies should also provide attractive but realistic business plans to show how the debt can be serviced. Lastly, founders should be able to provide good visibility on downside projection factors, including potential cost reductions, future revenues, assets that can be liquidated, and potential third-party buyers.
Loan Size
“What is the dollar amount I will receive?”
Loan Duration
“When does it need to be repaid?”
Loan Price
“What are the fees and interest rate?”
Timing of Amortization
“When do I have to start paying back the loan?”
Covenants
“What behavior could trigger a loan default? What are the financial and non-financial requirements?”
Flow Tip: The price of the loan is not just the interest payment. Lender fees will increase the cost of the loan. To calculate the approximate price of the loan, take all fees, divide them by the duration of the loan, and add to the interest rate.
When it comes to deciding which venture lender to work with, it is important to look at their past and current investments. If possible, look into case studies on their website or conduct reference calls to gain more perspective from past investees and to see how the firm behaved during tough times with other companies.
Fundamentally, venture debt exists to make venture more efficient.
It allows companies to achieve more progress ahead of the next valuation event and to increase the certainty of reaching critical milestones, while minimizing the dilution that would occur with traditional equity financing.
Flow Capital provides founder-friendly growth capital for emerging and high-growth companies. Through revenue-based financing and venture debt, founders, c-level executives, and other senior leaders are able to curate the best investment structure that fits their business.
To learn more about venture debt, read our Founder’s Guide to Venture Debt.
