What is Venture Debt? – Series 1 of 4

28 August 2018,   By   

As an early stage startup, your most prominent concern is probably access to capital and securing the first 18 months. You do not want to see the fruits of your early work dying before they hit the market. You demand supplemental forms of financing that provide your company with the required capital at a reasonable cost.

Venture debt is an essential part of any entrepreneur’s toolkit to respond to this demand – but is it suitable for early-stage? We gathered in this 4 part series critical and general information on venture debt. We would like to give you an overview of this rising alternative to traditional Venture Capital by answering the most frequently asked questions we received during the last months.

 

So what is Venture Debt?

Venture debt is a form of debt financing for venture equity-backed companies that lack the assets or cash flow for traditional debt financing, or that want greater flexibility. Patrick Gordon, Kaufmann Fellows. 

Venture Debt is provided by banks, finance companies and funds and is generally structured as a three to a four-year term loan with warrants for company stock – enabling an equity kicker and serving as collateral to protect the downside.

The expected returns on venture debt capitals usually range from 12–25% in monthly repayments in association with loan interest and equity returns. (IPFS, 2016) Lending to early-stage companies is riskier than the interest rates. Therefore, lenders also take warrants while lowering the rates. (Denning, 2017)

Venture debt is an attractive option to finance business because it amounts to less equity dilution and it does not require valuation and is, therefore, a fast alternative. (Trinity Capital Investment, 2018) Furthermore, venture lenders need no board seats, and in comparison with equity, the due diligence procedure is less time consuming – because they are collateralised in the first rank with equity.

 

There are generally three types of venture debts:

  • Growth capital is structured as a term loan and can be used to replace an equity round or provide additional working capital
  • Accounts receivable financing allows revenue generating startup companies to borrow against their accounts receivable items
  • Equipment financing is structured as a lease and is used for the purchase of equipment. (Alex Erhart, 2016)

 

In our next article, we will compare venture debt and venture capital and their differences.