There are about a million ways to finance a business, and venture debt is one of the most popular ones. To put it simply, venture debt refers to a variety of debt financing products offered to early and growth-stage venture capital-backed companies. It is also known as venture lending. It is usually provided by specialized banks or non-bank lenders to fund working capital or capital expenses. Venture debt is an attractive financing option, especially when structured well for the following reasons.
- The people spearheading the venture lending do not require board seats, so that puts less political pressure on the already existing board members. It also reduces any chances of wrangles among the people at the top.
- It results in less equity dilution for those who have invested heavily into the business, for example, the founders and additional investors.
- It doesn’t require a valuation to be set for the business.
- When you compare the due diligence process to equity, it is less exhaustive and less time-consuming, meaning you can work up a deal in a shorter time period.
Types of Venture Debt
Venture debt encompasses a broad array of loans that range from synthetic royalty loans to capital revolvers. However, there are four distinct categories that are used to classify different types of venture debt. These categories include lines of credit, term debt, equipment financing, and royalty monetization.
Lines of Credit
This is financing that helps to fund the company’s investment in short-term assets. This covers things such as accounts receivable and equipment. It is usually flexible to also cover the expenses incurred with daily operations as well as payroll. This is especially important during the early stages of growth.
Equipment Financing
This is primarily used to fund expensive capital goods such as tools and equipment. The repayment period is set up in a way that it aligns with the estimated life of the equipment that has just been purchased. It is, however, worth noting that equipment financing isn’t as useful or effective for asset-free companies.
Royalty Monetization
This type of venture debt is structured based on the anticipated revenue stream of the borrower. This means that if the revenue performance changes, then the loan payments will fluctuate relative to a predetermined multiple of the original loan. Some of the upsides of this are that the borrower doesn’t need to be capital-backed and that the financing is non-dilutive and doesn’t have minimum principal payments.
Term Debt
Just like the name suggests, this is a type of loan that is set to be repaid over several years (term). Payment is via fixed interest rates which makes it relatively easy to predict the venture debt for both borrowers and lenders.
Benefits of Venture Debt
There are quite a number of benefits enjoyed from venture debt which explains why it is a popular mode of financing.
- It fuels growth by providing capital with minimal equity dilution.
- It bridges to the next round of financing at a higher valuation.
- It enhances liquidity by strengthening the balance sheet.
- It achieves a more balanced and less costly capital structure.
