Venture debt of funding provides a short-term loan with a high interest rate. But is this financing option appropriate for startups with no track record?
Short-term
Unlike bank loans, venture debt is not backed by collateral. It is a loan to promising companies that have raised capital from venture capitalists. In most cases, the term of the loan is three years. However, there are some instances when a company is able to restructure the debt.
Lenders have more freedom with venture debt, so the interest rate is typically higher. Depending on the lender, the interest rate may be six to 10%.
Despite the high cost of venture debt, this type of financing can provide a quick source of cash for a growing startup. It can also help extend the cash runway of a high-growth company.
When choosing a lender, make sure you find a lender who will work constructively with you throughout the duration of the loan. A good lender will be there when you need them, but will not distract you from your business.
Most venture debt lenders will charge a commitment fee. This can be a flat fee, or a percentage of the total commitment. This fee is used to compensate the lender for keeping the money available. Some lenders will also charge additional fees, including pre-payment and final payment fees.
Non-bank lenders
Traditionally, venture debt was supplied by specialized venture lending firms. However, the market has been greatly disrupted over the past couple of years. Banks have entered the space and are now offering a wide range of loan products. The competition has forced some venture debt firms out of business. While there are still a few non-bank venture debt lenders around, it’s difficult to find a firm that offers competitive rates and terms.
Most non-bank venture debt lenders offer larger loan amounts than banks, but they are usually more expensive. Banks are subject to a variety of regulations and can only advance a certain amount to each company. The cost of capital is also lower, making bank loans a cheaper option.
Depending on the lender, a company may need to sign a term sheet, a legal document that describes the rights and obligations of the parties involved in a loan. This document can include a number of items, such as affirmative covenants, negative covenants and access to financial statements.
Is it suitable for startups with no track record?
Often used by fast-growing early stage companies, venture debt offers an inexpensive way to obtain non-dilutive financing. Lenders focus on a company’s business model and enterprise value, rather than historical financial performance.
Although venture debt lenders provide capital, the startup still has to repay the loan. If the company cannot pay back the debt, the lender may pursue remedies such as foreclosure. In addition, the startup may need to request permission from the lender to take on debt in a senior position.
Unlike traditional bank finance, venture debt is not suitable for every young business. It is only appropriate for start-ups with a viable business model and a track record. It is also difficult to secure venture debt for a company with a lack of assets.
One important factor to consider when determining whether venture debt is the right financing for your startup is to calculate your margin of error. This is the amount of money a lender will lose if your cash flow is not sufficient to cover expenses.
