There are different types of venture debt which provide a safety net and extend your cash runway between equity funding rounds. Venture debt offers performance insurance and a source of milestone financing.
In return for the higher liquidation priority, lenders typically receive warrants on company stock that can be exercised over a defined time period.
Commercial Paper
Venture debt lenders like to lend only to venture-backed companies with a strong growth profile. They look at a number of metrics that are different from those used to evaluate traditional loans, including the strength of the company’s founders (domain knowledge and vision) and top-level leadership.
They also want to see a well-established revenue model and healthy margins that demonstrate the business has a clear path to profitability. They are comforted by the quality of existing investors in the company and their willingness to support the business.
Venture debt providers often structure their financing instruments as non-convertible debentures, or NCDs, which are coupon-based, interest-bearing investments that include the right but not the obligation to subscribe to equity shares in the borrower at a fixed price within a certain time frame. This allows lenders to get a piece of the company’s future upside without sacrificing their own investment terms. This type of instrument helps entrepreneurs create a credit track record and grow their businesses while still managing cash flow requirements for operational expenses and paying off debt.
Revolving Credit Lines
Venture debt is a form of financing that provides cash for your business, like a loan from a bank, but with a few differences. Venture debt providers look at your company’s performance history, financial results, and the size of your most recent equity raise when making lending decisions.
Unlike equity investments, you do not have to give up any portion of your business ownership with this type of financing. Instead, you will typically be required to pay back the loan plus interest in a defined time frame. This can boost growth for your business by extending its cash runway and buying time to reach critical milestones.
As an alternative to a lump sum, revolving credit lines allow you to use your loan limit at will and only require P&I payments on the tranches you borrow. However, this option can be a bit riskier for lenders and may come with additional covenants and limits on your loan amount.
Growth Capital Term Loans
Venture debt can be a non-dilutive alternative to VC for companies that need a boost in their growth trajectories. Its repayment terms are often more flexible than traditional commercial loans, with payments based on a percentage of monthly revenues, or a fixed amount that’s proportional to your revenue performance.
Venture lenders may also include warrants to purchase shares of your company at a certain price within a given time frame. While these aren’t necessary for most venture debt deals, they can be an attractive feature for investors that want to take a smaller share of equity in exchange for lower financing costs.
Getting the right kind of venture debt for your company is important. Developing a clear pitch deck that showcases your company’s traction can help you find the best financing solution for you. Also, ensure that you’re familiar with the different types of financial covenants that venture lenders may impose. Failure to hit these financial milestones can trigger higher interest rates on any remaining loan balance or even the termination of your lending relationship.
Warrants
Venture debt providers often use a variety of financial instruments to create unique loan products for start-ups. These can include non-convertible debentures, stock warrants, and rights to invest equity in a company. These instruments are designed to compensate lenders for their high default risk and typically include the right to buy shares of a borrower at a predetermined price within a specified time period.
Venture capital-backed companies typically require significant working capital to achieve growth milestones and reach profitability. These companies have usually given away a fair share of equity in previous rounds of financing, which can dilute company ownership and limit future capital raising capacity.
In this case, VC-backed businesses can access venture debt to extend runway between equity rounds, which can provide them with enough room to raise additional funding from other investors or tap public markets before needing to restructure or monetize assets. In some cases, a business can secure venture debt with a royalty monetization plan that pays back funds based on the company’s revenue performance.
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