Looking for Funding for Your Business? You Should Know About Venture Debt. Looking for a smart way to secure financing for your company? Here's everything you need to know about venture debt.
By Peter DeCaprio Edited by Russell Sicklick
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Whether you're a small business owner or an aspiring entrepreneur, you've probably heard of venture capital. This popular private equity financing strategy is typically employed by investors looking to capitalize on the growth potential of lucrative startups and emerging companies. However, most people haven't heard about its loan-based counterpart — venture debt.
In the post-pandemic age, venture capital is rapidly becoming the go-to tool for entrepreneurs seeking financing for their business to boost their cash flow. It's also used to support their provider with minimal equity dilution.
Related: Why Venture Debt is Gaining Popularity
Below is information about venture debt, with everything you need to know from how it works to types and key benefits.
Venture debt – overview
Venture debt is essentially a type of debt financing that startups and emerging companies choose to complement their equity venture financing. Unlike traditional methods, this form of debt financing requires no collateral as lenders (banks and other financial institutions) understand most entrepreneurs and startups don't own substantial assets. Therefore, they're compensated with the business's stock warrants on common equity. They can convert these warrants into common shares in the future for returns based on the company's appreciation.
Moreover, venture debt is typically offered to individuals or startups that have completed many rounds of venture capital equity financing. They are simply looking for positive cash flows to apply for conventional loans. Thus, the debt term lasts no longer than three or four years. The lenders decide the principal amount to be paid (typically 30 percent of the total amount raised from the last round of equity financing) with interest.
Main types of venture debt
A line of credit
This is the most common type of venture debt. It helps companies fund short-term assets (mainly equipment) and facilitates daily operations. The line of credit offered over a pre-specified period is revenue-based, meaning it can change according to sales and customer retention, among other factors.
Term debt
This is a loan type that borrowers can repay over several years with a fixed interest rate. Due to its predictable nature, this type of venture debt is a great option for businesses looking for large investments.
Convertible notes
With convertible notes, borrowers don't pay interest payments. Instead, the holder of the notes receives company shares in a future fundraising round. Since this venture debt type involves interest, it has an expiration date. If funds aren't generated, the borrower has to pay the amount in full.
Key benefits of opting for venture debt
Startups and small businesses can benefit greatly by taking on venture dept. This instrument offers users a balanced capital structure and doesn't require financing collateral or board governance. Plus, did you know companies such as Uber, Spotify and Airbnb have utilized this tool to fuel and accelerate their growth?
Related: When Is the Best Time to Raise Venture Debt? Here's the Key.
Some of the key benefits of venture debt for borrowers
A great alternative to equity financing
For years, equity financing has been a great way for businesses to seek the funds they need but often at the cost of shares dilution and control. Venture debt allows borrowers to raise the funds they need and repay the loan by generating cash flow and increasing profitability. In the process, they avoid equity dilution and maximize control of their operations and brand.
A great way to increase cash runway and capital
Venture debt can be the intermediary between equity financing rounds and help you achieve different financial milestones. Moreover, you can use this strategy to increase capital with timely investments and repayments. Plus, you can operate with relatively fewer risks since you don't necessarily need a steady income stream or substantial assets.
Prepare for funding rounds without sponsorships
Utilizing venture debt is the best way to kick-start operations in an unfunded or unsponsored startup. Using this tool, you can get everything started and work on improving operations and different functions (marketing, sales, R&D, etc.) to accelerate growth and build long-lasting relationships.
To summarize, venture debt is a powerful tool that provides startups and small businesses with a flexible, cost-effective and non-dilutive way to get the funding they need to grow and scale their operations.
With this method, owners can build a solid foundation. They can improve their chances of acquiring future equity financing. Financing they'll need to roll out new products or services, open new facilities or take on new digital transformation initiatives without sacrificing control or their long-term vision. However, you have to find the right lender and venture debt type for your needs, which requires professional guidance from experts in this domain.
Related: 4 Reasons Why Borrowing Money Is Usually Better Than Giving Up ...
