Is Venture Debt A Better Way To Finance Growth Capital?

Written by Gene Wright. Posted in Funding/Lending

According to the National Venture Capital Association (NVCA), the venture capital (VC) market in America is shrinking, with the number of VC firms significantly decreased in recent years. The NVCA reports that VC investment and under-management are also on the decline.

This presents, in theory, a problem for start-ups: with fewer options, entrepreneurs have less negotiating power. However, the concept of venture debt still presents a viable option for established start-ups so long as they have solid revenues to bridge a growth cycle.

What is Venture Debt?

Complementing equity financing, Venture Debt is used by revenue-backed companies that are looking for financial security with growth capital.

Venture Debt firms only make loans for very fast-growing, late-stage start-ups, with solid revenues and profitability. These types of situations are almost exclusively designed for growth capital, not early stage companies or ventures with no clear means to pay back a loan.

What are the Benefits of Venture Debt?

  • No Dilution: Unlike venture capital, the start-up doesn’t give up equity. Stakes in the company will not be diluted.
  • Extra Runway: You have more time to reach your financing goals.
  • No Overhead Burden: Just like equity, the loan’s not amortized for a period of time and it’s structured so the business can pay it off at the end of the period.
  • Cheaper than Venture Capital: Venture capitalists typically request five to seven times, or 60 to 80%, in return for their investments. They think business will be worth five times as much as money they invested. For $500,000, the startup could pay up to $2.5 million in five years to take an angel investor out. Venture debt, on the other hand, usually charges the significantly lower rate of 12-15% for their capital.
  • Pre-paid Interest: Venture Debt typically carries a nine- to 18- month period of interest-only payments, sometimes with the option to pre-pay the interest. A business can pre-pay their interest with no debt overhead for that period, before the loan repayment is due. This assists companies with long-term needs.

How Does Venture Debt Work?

There’s only so much money an entrepreneur can raise through individual avenues; however, start-ups are now using combinations of different types of investors to raise the sums they need. Under the Invest Georgia Exemption (IGE), if a company needs to raise $750,000 or more, it can receive up to $500,000 from Angel Investors and get the remaining $250,000 from debt. Many investors like Venture Debt because it does not dilute their ownership of the company.

What’s in it for the Investor?

The underwriting process for Venture Debt is very similar to the process for banks. The underwriter looks at what kind of assets can be recovered if the project fails, like physical buildings, manufacturing facilities, or IT equipment.

In some cases, such as London-based Crowd for Angels, investors are not required to pay fees and have certain tax exemptions.

Though we’re still in the early stages of crowdfunding, there are some real benefits of using Venture Debt and venture capital together. While helping local start-ups reach their full potential, Venture Debt provides new, feasible financial options for start-ups in a market of declining venture capital.

References: 

1. The NVCA reports that VC investment and under-management are also on the decline: http://www.nvca.org/index.php?option=com_content&view=article&id=344&Itemid=103

2. In some cases, such as London-based Crowd for Angels, investors are not required to pay fees and have certain tax exemptions: http://www.crowdfundinsider.com/2014/05/39049-crowd-angels-launches-brand-new-debt-equity-crowdfunding-platform/

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