Mastering venture debt:
A comprehensive guide
Discover how this type of funding could accelerate your pathway to growth
Is your business scaling rapidly, but could do with some extra capital to support its growth? Are you starting to explore your fundraising options but are worried about the likelihood of being approved for a loan? Look no further…
Our comprehensive guide to venture debt explores everything there is to know about this specialist product that bridges the gap between bank loans and equity capital. From the type of business profile that is a good match for venture debt, to the fundraising process and eligibility criteria, continue reading to discover how you can use venture debt to get growth going.
What is venture debt?
Venture debt is a type of growth capital provided by specialist lenders to high-growth, rapidly scaling businesses.
In conventional terms, venture debt is a business loan, but it is one that is particularly effective for small to medium businesses that have an established business model and clear prospects for growth, but that are yet to achieve profitability.
Venture debt funding is usually available earlier in a business’ lifecycle and in larger amounts than traditional bank loans and often venture debt lenders do not require personal guarantees or a seat on the company’s board, making it a great option for innovative businesses that are expanding rapidly, need investment to secure their next stage of growth, but have no desire to lose control by diluting equity.
What type of business would benefit from venture debt?
Fast-growing, young businesses that have a limited trading history and little or no track record of profitability usually struggle to borrow money from conventional sources such as the high street banks, because they do not meet their strict lending criteria.
The consistent rejection can leave business leaders feeling that they have few alternative options for funding their growth and that their only choice is to turn to equity funding, thus giving up a large chunk of ownership and possibly even ceding control to their investors.
Venture debt however, combines the normal features of a bank loan with the aspects of venture capital that have traditionally been associated with equity finance. Venture debt providers for example, are as interested in the current and forecasted performance of a business as they are its historical financial performance. This is a significantly different approach from the major banks, which usually require a strong track record and multiple years of financial data before they will lend.
These features make venture debt an excellent match for start-ups and high-growth companies that do not yet have the type of positive cash flows that a bank looks for, or the valuable assets that a bank typically expects borrowers to provide as collateral against their debt.
This doesn’t mean that venture debt is suitable for very early stage start-ups that have no track record or significant revenues, as the business still needs to be able to service the debt, but if you have a proven business model and strong prospects for growth, venture debt could be the perfect tool to help you get there.
How to use venture debt
As a type of growth capital, venture debt is usually used to support activities that underpin a business’ growth. These activities include:
♦ Extending your cash runway
Venture debt can provide a useful source of headroom for a loss-making company as it closes in on profitability. Because venture debt lenders focus on a firm’s enterprise value and business model rather than its historical financial performance, businesses do not need to be profitable to be eligible for these types of loans. By extending cash runway, venture debt provides a little extra time (and resource) to help a business reach profitability.
♦ Funding M&A activity
Fast-growing businesses often plan to increase their speed of expansion by implementing a growth strategy based on mergers and acquisitions. However, this model means that companies must have the funds in place to enable them to respond quickly when new opportunities arise.
Once secured, venture debt can be drawn down in tranches over the duration of the loan, making it perfectly suited to acquisition growth strategies.
♦ Providing working capital
High-growth businesses that are yet to hit profit must carefully manage their cash flow, but they will occasionally need funds for working capital requirements, such as stock purchases. It can be particularly difficult for young businesses with seasonal demand fluctuations to manage these needs. The flexibility of venture debt makes it well-suited to this purpose.
♦ Supporting capital expenditure
Fast-growing, young businesses often struggle to fund the activities that would secure further growth. Investment in new equipment for example, or additional software licences that mean the business can service more clients. Venture debt can be a handy tool in funding such needs, giving businesses the capital to invest in growth that might otherwise take years to achieve.
How to raise venture debt
1. Speak to an expert
If your business is a similar profile to that of an ideal venture debt candidate, no doubt you have already spoken to a number of different lenders about your options (and perhaps been left disappointed by their responses). But fast-growing businesses are a whole different entity to the types of organisation that most major institutions are used to lending to.
You need a specialist, tailored approach to fundraising and you need to speak with experts that are experienced at working with high-growth, rapidly scaling businesses.
Trusted, or recommended corporate finance advisors are a good place to start, but if you’ve already been speaking to an advisor and are still unsure about your options, our own lending experts are on hand to help. You can book a completely free, no-obligation call with them here – they’ll ask about your business and your growth goals and will provide a recommendation as to your next steps.
(P.S. If your business does not match the profile of an ideal venture debt candidate, check out our Guide to Types of Growth Capital – it may be that another form of funding is a much better fit!)
2. Start the application process
Preparation is the key to this stage and you can find more detailed information about how to prepare for venture debt fundraising here, but having the following documents ready is a great start:
- Financial information
- Company profile
- Business model
- Market analysis
- Management team profile
- Funding requirement
- Plans for servicing debt in a downside scenario
- Business goals
3. Secure an offer
Once you have decided on a lender and you have impressed them in turn, they will make you a funding offer by issuing you a term sheet.
The term sheet is a legally binding document that will outline all the details of your agreement, including things like the loan amount, repayment schedule and pricing model.
Once an offer has been made and both parties are happy, the lender will begin the due diligence process to ensure they have an accurate picture of the past, current and forecasted performance of the business.
4. Get growth going!
With due diligence and legals out of the way, the lender can release your funds. Time to get growth going and invest the capital in the activities that support your goals.
What are the eligibility criteria for venture debt?
To give a definitive answer to eligibility for venture debt is tricky, because every lender will have a slightly different risk appetite when it comes to earlier stage business investment. Working with specialist growth lenders is a good way to improve your chances of securing investment, because they are experienced at working with rapidly scaling, innovative businesses like yours.
At Growth Lending we like to see:
- Revenue of £2m+
- Reasonable visibility of future income i.e. contracted orders, recurring revenue models
- High-growth sectors such as SaaS, technology, life science and professional services
- B2B business model with an established customer base
- Goal of profitability within 12 months against reasonable growth assumptions
- Firms that are privately-owned or equity-backed
How much does venture debt cost?
Growth capital loans tend to be priced individually, depending on the needs and circumstances of the borrower. For example, companies at an earlier stage of their development or with a faster cash-burn rate will normally pay more to reflect the increased risk to the lender.
Venture debt pricing typically incorporates three elements:
- A fee of between 1% and 2% of the approved loan amount
- An annual interest rate of between 10% and 12%
- An equity kicker worth 10% to 20% of the loan – this final element is usually structured as a warrant, giving the lender the right to buy a small portion of equity at a fixed price during the term of the loan
The loan is then repayable over a period of several years – at Growth Lending we offer terms of 3-5 years.
Although repayments usually include both interest and capital, some borrowers opt for an interest-only period of between six and 12 months at the beginning of the loan if their lender offers it, giving them additional opportunity to invest the capital in growth.
Loans can also be structured to suit the borrower: some businesses prefer to draw down funding in tranches, as and when they need the money, which reduces the total interest cost.
Venture debt can be a more expensive funding option than traditional bank finance, so it won’t be suitable for every business. It does however, provide a much-needed middle ground between bank loans and equity, making it perfect for fast-growing firms that need non-dilutive capital to fuel various types of growth.
If your business is looking for growth capital and you are interested in gaining a deeper understanding of the cost associated with a venture debt, download our handy calculator.
Venture Debt Loan Calculator
Download this free and easy-to-use tool to help you budget, compare the cost of different loan providers and to ensure you work with a lender that understands and matches your needs.
