Venture debt is a complex, often misunderstood financing product that venture-backed startups typically use. In the past decade, venture debt has become an increasingly important asset class for VC-backed companies, and it’s now a standard part of any startup’s capitalization table.
Venture debt comes in many flavors and has evolved over time to meet the needs of entrepreneurs. In its simplest form, venture debt is a loan made to an early-stage company backed by the company’s assets (and their founders) as collateral. The loan amount typically ranges from $1 million to $10 million, although larger loans are possible. The loan term usually ranges from one to four years, with interest paid monthly and principal repaid at maturity.
What are Venture Debt Benefits?
The benefit of venture debt is that it allows startups to postpone taking on additional equity investors until they are ready to accept their terms. If a company needs cash and cannot find an investor willing to invest on the terms they want, they can choose to get a loan instead.
Besides, venture debt also provides an alternative source of capital for companies that have already raised funds from equity investors but need more money before making their products profitable. A company may need additional market research or product development before generating enough revenue to be profitable.
By providing an alternative source of capital, venture debt allows companies to focus on developing their products without worrying about raising funds from investors at the same time.
What’s the Difference between Traditional Bank Loans and Venture Debt?
The key difference between venture debt and traditional bank loans is that venture debt is senior secured debt guaranteed by company ownership equity (typically Series A preferred stock). That means that in the event of default or bankruptcy, the debtor forfeits some or all of its equity before any other creditors can be repaid.
Who is Eligible for Venture Debts?
Venture debt is a form of financing that companies can apply for in addition to, or as an alternative to, equity financing. Although venture debt is not the right solution for all companies, it can be beneficial in certain situations.
For example, venture debt might be a good choice when a company has already received multiple rounds of equity financing and needs to extend its runway (the amount of time the company has until it runs out of cash) before bringing in another round of funding from investors.
Venture debt is also a good option if you have already raised equity financing but don’t want to sell more shares to your investors. In this scenario, you might want to take out venture debt instead because by doing so, you preserve the equity positions of your current shareholders.
In contrast with equity financing, which is based on your company’s value and potential future earnings, venture debt is often secured against assets such as equipment or property. A lender will therefore have more security when lending money in this way. This means that they are more likely to lend money if they believe they will get their money back if things go wrong.
Finally, venture debt refers to debt financing provided to early-stage, innovative or rapidly growing companies. It can be an attractive alternative to equity financing as it preserves equity ownership and control within the company. In addition, venture debt financing may offer greater flexibility at the time of exit since lenders have no voting rights and are paid after equity holders as a general rule. For venture capital investors, venture debt can help conserve cash while compressing the time to exit.