Venture debt, often known as venture lending, refers to several debt financing products made available to venture capital-backed enterprises at the early and growth stages. Venture debts are typically provided by technology banks and dedicated venture debt funds and include a term loan or equipment lease of three to four years.
When properly structured, venture debt can be an appealing funding alternative for the following reasons:
- As a result, entrepreneurs and investors experience reduced equity dilution.
- It is not necessary to establish a business valuation.
- Board seats are not required for venture lenders.
- When opposed to equity, the due diligence procedure is often less exhaustive.
Benefits Of Venture Debt
Reduce the Average Cost of Capital
The first benefit is that the venture debt can reduce the average cost of capital by providing minimally diluted finance for businesses to scale quickly. This is especially true when raising venture financing in conjunction with an equity round because equity is the most expensive growth capital due to its high dilutive nature.
The second advantage is that venture debt allows flexibility. Not only does venture debt not necessitate board seats, but the loan itself can be used as a cash cushion if the company has any setbacks along the road. This is a significant distinction from senior-secured financing, which often requires that a specific underlying asset be financed, pledged as security, and provided personal guarantees.
When To Raise Venture Debt?
There are various scenarios in which venture debt makes sense for entrepreneurs and their venture capital investors.
With Equity Raise
The best time to raise venture debt is concurrent with or immediately after raising equity. The momentum is strong, the diligence materials are on hand, and the money is in the bank. Venture debt can supplement a portion of the equity requirement while minimizing equity dilution.
Between Equity Rounds
A startup company’s cash runway can be extended by using venture loans to achieve the next milestone achievement before their next equity offering, resulting in a better valuation and reduced equity dilution.
Fund Large Capital Expenditures
Venture debt can be used to fund substantial capital expenditures without diminishing the company’s cash reserves. Equipment leasing can provide “just in time” finance to purchase assets when needed, with payments spaced out over three to four years.
As An Insurance Policy
Venture debt can act as an insurance policy for the company, removing the need for an emergency bridging round and allowing the company to raise its next equity round once the company is back on track.
Fund To Profitability
A company’s bridge to profitability can be aided by venture debt. This is an excellent use of debt since it moves the company forward during a vital expansion era and eliminates the need for a final round of equity financing.
One should only raise venture debt if one is confident that the firm will have enough cash flow to service the debt or if one is convinced that one will be able to raise another round of equity in the future to repay the loan.