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Given how attached entrepreneurs can get to their startup, it can sometimes sting knowing that the main way of raising funding is through Equity Financing. It’s often a sobering fact of doing business that you often need to give away parts of your business to help it succeed. However, this puts a limit on how much raising capital you can do before you start to dilute your shares.
Enter Venture Debt - a far too often forgotten option for raising growth capital for early-stage companies. Early-stage companies can leverage venture debt to get better control of the costs of capital.
What is Venture Debt?
So what exactly is venture debt? Essentially, it’s a form of debt financing, used by early-stage companies. This can be viewed as something of a loan, where money is given by the venture capital firm with an expectation of being repaid - though there is a little difference (more on that later).
The most important takeaway from this venture debt primer is that venture debt doesn’t require that equity be given away. It can be used as a complementary way of raising capital during the fundraising stage for startups.
How Does Venture Debt Work?
Remember when we said that venture debt is a little different than conventional loans? Generally, this is because venture debt is fairly short-term in nature, intended to last only three to four years.
Like other loans, venture debt has interest rate payments, often based on the prime rate. About 5% to 20% of the value of the loan is also given as warrants to the lenders in recognition of the risk involved. (These warrants often are allowed to be converted into common shares). However, because banks tend to understand the risks involved, they generally don’t include many covenants (conditions or restrictions on the loans). This makes venture debt one of the easier ways to get growth capital.
Venture Debt vs. Equity Financing - Pros and Cons
So how exactly does venture debt measure up as a method of raising capital compared to equity financing or a standard bank loan?
The major pro to venture debt is that it lets you get more growth capital without diluting the equity stake of the existing investors in your venture - which can include you and your employees!
Compared to other debt financing methods, venture debt financing is also useful in that it generally doesn’t require much in the way of collateral - perfect for early-stage companies that may not have much to put up.
However, there is one major downside. In short, debts need to be repaid. If there’s any defaulting on the repayment terms, the managers of the debt can call the loan - which can quickly spell liquidation for a startup.
How to Apply for Venture Debt
Generally, venture debt is acquired soon after an equity round is done, as the startup goes looking for more growth capital. To get venture debt, you’re going to have to find a company willing to help you with raising capital. Just like with equity investing, you’ll have to prove to that company that your startup is likely to repay the investment (in this case, repay the debt). A good CFO consultant can help you develop these kinds of partnerships.
How to Manage Venture Debt Loans
It’s best to view venture debt as a bridge of sorts - something to help you manage the costs of capital in between your equity rounds. Remember that venture debt tends to have a short repayment period, so you should carefully consider your finances to see how likely it is that you will be able to repay it. However, it can be an incredibly useful form of growth capital to “tide you over” between those rounds of raising capital.
If you’d like more information on how to apply for Venture Debt, or how to find a Venture Debt partner, make sure to contact us for a free consultation. You have nothing to lose but so much to gain.