What exactly is Venture Debt?
It is a type of loan offered by Funds, Family Offices or even Banks that is designed specifically for early-stage startups positioned for high growth without having to dilute equity and those who already have venture capital backing. It can provide a bridge so that a founder can delay raising an equity round, grow the company strongly and then attract higher valuations. This allows founders to maintain higher ownership of the company.
The First Rule of Venture Debt
The most important thing to keep in mind here is that Venture Debt follows equity. This is not a replacement for it. Here, Venture Debt lenders use venture capital as a source of validation and primary yardstick for underwriting a loan. Venture debt availability and terms are always contextual. Loan types and sizes vary significantly based on the scale of the business, the quality and quantity of equity raised to date, and the objective for which the debt is being raised.
Debt vs Equity
Equity
– The repayment is not contractually required – Long-term capital with several rights
– Difficult to restructure equity
– Higher risk-adjusted returns
Debt
– Repayment terms are fixed at the beginning
– Short-term or long-term capital
– Purpose of the capital disclosed in advance (limits on the usage of funds) – Restructuring possible
From the perspective of the founder
A founder will towards Venture debt to avoid ownership dilution and to fund its business for the next stage of growth for attracting larger investors at a later stage of the company and command higher valuations. A founder who can bootstrap a company without the involvement of VC funds might face difficulty to borrow Venture Debt as it requires that VC funds should have already been involved in the company. The founder in this case can borrow through traditional routes such as banks but needs the business to be cash flow positive for the banks to provide the loan.
– Venture Debt usually isn’t available to seed-stage companies
– Usually, VCs don’t like to invest and take equity if a large proportion of this money is used to repay old debt
