If you’re finding barriers to getting the extra financial help you need to scale (especially if you're a new company without credit history), you're probably wondering:
We interviewed Jeeves’ in-house financial experts to help you make an informed decision on venture debt and other options. Our article will cover:
Venture debt is a cross between a traditional bank loan and venture capital (VC) and is extended to VC-backed companies that need extra liquidity. Venture debt is financing that usually takes the form of a loan, but not always.
Also known as venture lending, venture debt is commonly used by VC-backed early and growth-stage startups to:
However, even later-stage VC-backed companies and private equity-back businesses can tap into venture debt financing, especially when they need an extra cash flow boost to break even or become profitable.
Venture debt is more forward-looking than traditional debt.
Traditional bank loans will underwrite your company based on metrics like past performance and credit history. But most early-stage companies haven't been in business long enough to meet these requirements, even though they have successfully raised equity.
With so many barriers to entry with a bank loan, many early-stage companies can apply for venture debt immediately after an equity funding round. Venture debt lenders will underwrite you based not just on past equity but on your potential for growth.
You can also use venture debt if you’re in a growth stage. Perhaps you’re focusing on building up your revenue first and on the verge of break even or profitability. Venture debt financing provides a boost to your runway to scale your business.
It’s common for venture debt providers to put certain financial covenants in place to incentivise repayment. Covenants are a set of agreements made between the borrower and lender that outline the criteria or behaviour that the lender must fulfil for the loan to progress.
For example, the borrower might not always be given the full amount of the debt all at once. You might be approved for $3 million but have only $1 million dispersed to you initially. For the lender to disperse the next $1 million, perhaps you have to hit a specific revenue or growth target for the remaining $1 million.
Some companies can negotiate venture debt without financial covenants if they are well-capitalised or high-growth businesses.
Warrants may also come with a venture debt agreement. This is where the lender has the right to purchase equity in a company at a later date. Warrants offer downside protection and upside potential for the lender.
For example, let's say you don't hit your goal of raising another round or can’t repay your debt. In these cases, the lender can buy equity, which will be more valuable when the company reaches their subsequent funding round.
Warrants are viewed as a deal sweetener for the lender. However, they are typically small at 2% of the company’s valuation, much less than venture capital equity agreements.
Venture debt lenders are the senior secured lenders in a company’s capital stack — meaning you would repay them first because they’re at the top of the stack. The caveat is if you also have a bank loan, which means the bank is the first on the stack and you would pay them first.
Here are the most common venture debt terms:
You can negotiate a balloon loan structure with your lender in some situations. This is where you pay interest only or nothing until the loan matures, at which point you pay the remaining balance all at once. Balloon loans are useful if your company has high expenses and you’re confident you can raise a substantial next round of funding.
To raise venture debt, startup founders have multiple financing options. Banks and non-bank lenders offer venture debt, and there are also specialised venture debt lenders for specific niches.
One of the most common ways to acquire venture debt is through referral. This is because many VC firms have access to their own venture debt lenders. As they regularly do business together, there is trust, and they will simply refer the company they just backed to venture debt lenders.
To apply for venture debt, you'll be using many of the same financials you show to venture capitalist firms. So for convenience, apply for venture debt and VC funding simultaneously as you have all the documentation already.
Also, look for venture debt funds when you have just raised capital; this is when your financials look the best. If you wait and have far less money in the bank, you might not secure enough debt to hit your next round.
Just like applying for venture capital, with venture debt, you will need to show the following:
Need some help in crafting your product or service's value prop? Find inspiration with our post, 11 Powerful Value Proposition Examples & Why They Work.
Venture debt lenders prefer venture-backed businesses because this indicates the company is well capitalised, which increases the likelihood of successful repayment. Venture debt lenders will also want to know who your VCs are, including their experience and how much they will advise the company.
The team behind the company is a critical part of the acceptance process. The lenders will enquire as to their expertise and how capable they are at managing a team to deliver on their business plans.
Lenders will want to see that you have a proven revenue model and strong product fit in a large market. And more importantly that you have a high probability of scaling your business into high-profit margins.
They will look at how you plan to operate, communicate and share data together. Also, it’s essential to show how you will manage the combination of corporate interests of investors, managers and staff to provide clear communication for all.
The most common use cases for venture debt are to help the company grow and to bridge the gap between funding rounds.
Here’s when it can also makes sense to use venture debt:
SaaS is typically an excellent industry for venture debt because of the recurring revenue and the monthly or annual company contracts.
Their scalable business model also makes them very sellable and more lucrative to invest in. Venture debt firms will see the potential, whereas a bank might deem them too risky.
Other technology companies without assets or a track record can benefit from venture debt also.
Your venture capital investors will also like to see you take on venture debt instead of too much venture capital investment. It benefits these early investors because it minimises equity dilution.
The traditional alternatives to venture debt are venture capital or traditional debt.
In this section, we’ll first summarise the three most common forms of debt in a comparison table: venture debt, venture capital and traditional debt.
When to use venture capital over venture debt?
VC firms will invest in your company based on potential and venture capital has fewer requirements than venture debt. Here’s when it makes sense to use venture capital over venture debt:
There are two main types of debt financing: traditional loans and digital debt. Both may require you to have positive cash flows before they can extend a line of credit.
Use debt financing instead of venture debt when you don’t plan on becoming a high-growth massively scalable company and are too small to access venture capital. If you’re not a VC-backed company, you most likely can’t access venture debt.
You can also choose debt financing when you want to:
Speed is the main difference between venture debt, traditional debt lenders and digital debt providers. Commercial banks can take months to finalise a loan whereas digital debt providers like Jeeves can fund you in a few days.
We hope this article provided insights on what venture debt is, how it works and when it's best used.
As we mentioned, other options might suit your company better depending on your size and stage, with venture capital also providing significant benefits.
If you're a growing company looking for a financial operating system built for global businesses, try Jeeves.