Breakdown of Venture Debt and How It Works
Also referred to as venture lending, venture debt is the various debt financing products that early and growth-stage venture capital-back businesses get. Technology banks provide venture debt and dedicated venture debt funds, and venture debt involves about three to four-year term equipment lease or loan. People can find venture debt quite an attractive financing option when they structure it appropriately for the following reasons:
- The due diligence process tends to be typically less exhaustive, unlike equity.
- Venture lenders do not need board assets.
- It doesn’t require a valuation to be set for the business.
- It results in less equity dilution for investors and entrepreneurs.
Venture Debt Benefits
Some of the benefits of venture debts include:
- Subordinated debt: venture debt can be subordinated with senior bank debt.
- Structured capital: people can achieve a more balanced and less costly capital structure.
- Enhance liquidity: it enhances liquidity and strengthens the balance sheet.
- Increase valuation: it acts as a bridge to the next round of financing at a higher valuation.
- Extend runway: people can extend the cash runway to accomplish the next milestone.
- Fuel growth: t provides growth capital with less equity dilution.
When to Raise Venture Debt
Entrepreneurs and their venture capital investors will find several situations where venture debt can be a smart financing option.
Fund to Profitability
A business can get a bridge to profitability through venture debt. The company will find it an excellent use of debt to propel it forward during a crucial period of growth. Therefore, it can also eliminate the need for a final round of equity financing.
As an Insurance Policy
The company can protect itself from potential delays or mishaps by using venture debt as an insurance policy. With that, they can eliminate the need for an emergency bridge round, enabling the company to get back on track after raising its next equity round.
Fund Large Capital Expenditures
With venture debt, businesses can finance large capital expenditures without depleting the organization’s cash balance. They can also get ‘just-in-time’ financing through the equipment leases to purchase assets as required, spreading the payments out over a three to four-year period.
Between Equity Rounds
Startup companies can use venture debt to extend the cash runway of the company. With this, they can achieve the next milestone achievement before their next equity raise. This case will lead to less equity dilution and higher valuation.
With Equity Raise
Immediately or concurrently after an equity raise is the best time to raise venture debt; there is cash in the bank, diligence materials are in hand, and momentum is strong. Thus, businesses can use venture debt to minimize equity dilution and augment a portion of the equity need.
When choosing a venture lender, a company must ensure that they select the overall best financing partner. Such a partner must possess competitive terms. The lender must encourage businesses to get the best terms they can. Companies must essentially view each financing option as a single solution, even when they have several financing vehicles. They must also compare holistically with other financing alternatives. Companies must also look out for positive references when choosing a venture lender.