The search for investors and lenders is important for companies of all sizes – and unfortunately not always easy. The reason: The collection of additional equity capital by new or existing investors costs companies additional shares. Loans, on the other hand, are often measured according to cash flow, which is not a suitable indicator for start-ups. This means that traditional forms of financing are often unsuitable for fast-growing companies. Venture Debt can close this financing gap.
Companies that previously financed themselves through equity providers and now do not want to further dilute the shareholder structure can fall back on the concept of Venture Debt. This financing model requires the borrower’s ability to raise additional capital to finance growth and repay debt. It is not based on historical cash flow or working capital as a source of repayment. In the vast majority of cases, venture debt financing is therefore synchronized with a traditional equity round or concluded within a tight timeframe after the traditional equity round. Both processes often take place very quickly one after the other – there are often only a few weeks or months between the financial statements.
Advantages of Venture Debt
The advantages of such an approach are obvious: the average cost of capital decreases and thus provides another good reason for the loan. The venture debt capital made available gives companies an extra degree of flexibility and thus extends the effect of the equity collected. Young, high-growth companies in particular can use such an approach to create even more scope for expansion and innovation. But they are not the only ones to benefit: In addition to financial security, Venture Debt gives companies stability on many levels: The additional capital enables the team to be expanded and the product to be further developed, thus increasing the company’s innovative strength.
From the perspective of the equity investors, the additional capital available is also a positive sign: For them, this increases the liquidity of the portfolio company, the momentum of the company gains further momentum and the reputation of the equity providers rises. At the same time, venture debt capital can be used to hedge against performance slumps or valuation hurdles.
Who is Venture Debt suitable for?
Typical venture debt borrowers are mostly fast-growing young companies that have already raised capital from institutional venture capital companies (VC funds). In the course of the initial financing, these growth companies regularly develop a clear strategy for further capital procurement, which also includes forms of financing in which no further shares need to be sold. Ideally, such a growth company is no longer at the very beginning of the start-up-phase but has already completed at least one large Series-A financing round or several smaller financing rounds. A possible benchmark of the financing size that the company should already have collected is around five million euros.
The industry in which the borrowing company is active is irrelevant. However, the business model should already have proven to be robust and scalable. In particular, the management team should be experienced and also be able to present a clear vision for the company and its further steps. Furthermore, the revenue and customer base should show sustainable growth. Which of the criteria mentioned in the course of the loan agreement which weighting receives, depends on the respective company, the required sum and the current situation. As a rule of thumb, the amount of the risk loan generally depends on the amount of the equity round and the current and forecast cash burn rate.
At first glance it may seem surprising to take on risk debts when the company has just raised new capital anyway. Irrespective of when the loan is to be financed, the creditworthiness and negotiating leeway of the borrowing company are the highest immediately after the new equity is closed. For all parties involved, Venture Debt thus offers a multitude of advantages which come to bear especially in the case of particularly strong growth and innovation plans.
Our guest author Oscar Jazdowski is General Manager of Silicon Valley Bank Germany. He has more than 30 years of experience in financing technology companies at all stages of development, from young start-ups to large multinationals.