ou’re probably here hoping Venture Debt is for you and you’d like to validate that fact with a bit of research. Well, there’s some good news
You’re probably here hoping Venture Debt is for you and you’d like to validate that fact with a bit of research. Well, there’s some good news and some bad news depending on who you are and depending on what stage your company is at right now. But before we get down to figuring that out, let’s take a look at what Venture Debt really is? Well, the terms are confusing for sure, take it at face value and you’ve probably assumed something else.
Venture Debt, also known as venture lending, is a form of Debt financing that was created to meet the needs of growing startups and pre-profit companies. To be more specific, for startups and companies that are already backed by Venture Investments.
So what it means for you is that it isn’t an alternative to venture capital, but is more like a complementary source of funds for venture-backed companies. And unlike Venture Capital investments it does not demand your company’s equity as collateral.
Venture debt works differently, unlike conventional loans. It doesn't require any collateral for the loan sanction, but your previous equity round is used to determine the principal amount. The debt is short to medium term, commonly up to three-four years. The principal amount would be typically 30% of the total funds raised in the last equity financing.
Since venture debt lenders provide loans to start-ups that are not yet profitable or do not have any hard assets (like SaaS or technology companies), the risk would be high. Due to this increased risk, venture debt lenders require higher interest rates than banks. In addition, the lenders would receive warrants on the company’s equity as a part of the compensation for the higher default risk.
Warrants are what sets Venture Debt apart from ordinary loans. Warrants are security that gives the holder the right (but not the obligation) to purchase company stock at a specified price within a specific period of time. Warrants are what make venture debt an expensive option for most startups since warrants devalue the company when it comes to raising future rounds.
Venture debt is a smart and critical source for today’s entrepreneurial companies. The start-ups use venture debt as a multipurpose tool in their growth strategy.
Let’s discuss the 3 primary uses of venture debt:
Now that you’re aware of what Venture Debt is, based on the stage your company’s in, it may or may not be the right choice for you. So what are the alternatives? There are your usual business loans that can be taken from banks and other financial institutions. In some cases, it's crucial that you have a good credit score and an appealing market strategy to ensure you can pick up this source of funding. The rest is pretty straightforward in the sense that there's a tenure to pay back your debt and additional interest that’s incurred on the loaned amount.
Another alternative is either raising funds through angel investors or venture capitalists. This is obviously assuming you haven’t done either in the past in which case Venture Debt wouldn’t even be an option for you. Unlike Venture Debt, you’re liable to trade stakes in your company for such an investment. The below table explains the exact difference between Venture debt and venture capital funding.
|Factors||Venture Debt||Venture Capital|
|Equity||The lender/debt issuer does not take much equity in a company.||The investors/VC’s will take the equity based on the valuation and the amount invested.|
|Repayment||Debt is repaid with interest over time.||VCs will make money by selling the equity.|
|Returns||Average venture debt returns are lower||VC returns are slightly higher than the venture debt|
|Qualifications||Only the companies with previous VC funding can be eligible for venture debt.||No previous backing is needed.|
|Companies that can opt for funds||High-growth companies||Early-stage companies also can be eligible for venture capital funding.|
|Company Valuation||There is no need for a new company valuation.||Equity investment requires a company valuation.|
|Due Delligence||Due diligence is usually not as thorough as venture capital funding.||There will be a thorough due diligence procedure undertaken.|
It isn’t so much when but if you should look at Venture Debt as a source of funding. You know by now that it only makes sense if you’ve raised equity in the past. So with that out of the way, there are a couple of reasons one would choose debt financing.
While there isn’t a fool-proof method for choosing the best lender for your business, there are a few tips to help you wade through the process and ensure you don’t land yourself in trouble.
In 2021, Indian companies raised over Rs 4,500 crore ($600 million) in venture debt, which was almost double the amount raised in 2020 (Rs 2,100 crore ($300 million))
Over 100 companies raised venture debt last year, including Urban company, Licious, Mensa Brands, and Zetwerk, with ticket sizes ranging from $2 to $25 Million.
There are a few alternatives to Venture Debt in the market today - especially for startups. Subscription-based Financing is one of them. SBF allows you to access the annual value of your periodic receivables.
Revenue-based financing is another option that gives you a term loan and allows you to pay it back based on a percentage of your monthly revenues.
Venture debt can be a good complement to equity because it allows businesses to extend their cash runway and reach their next goal. Existing shareholders may see less dilution as a result of venture debt, which does not require a new business valuation.
Venture debt can be raised a lot quicker than the other conventional fundraising methods. While the duration of the due diligence procedure influences the timeline, the full process normally takes 4 to 8 weeks.
Initially, venture lenders may offer a period during which the borrower just has to pay interest. Following the "interest-only" phase, the company continues to repay the principal in instalments (a process known as amortisation) until the final maturity date.
Although venture capital is the most common kind of startup finance, venture debt — which allows VC-backed companies to borrow money to raise funds — can be enticing to founders looking for a quick infusion of cash without giving up much equity.