In the past few years, venture debt funding has become a popular way for fast growth companies to raise capital. In fact, venture debt is growing faster than the venture capital market, reaching $28.2 billion in 2019 and $27.5 billion in 2020, according to data from Pitchbook. Used in conjunction with venture capital, venture debt helps extend a company’s runway and maintain the company’s current ownership until it can raise more equity capital. But it’s not just for new companies. Established national brands like Uber, Netflix, and Airbnb have all funded their businesses through venture debt.
Fast-growth companies use venture debt to ensure further growth, or to quickly secure needed funding when sudden changes happen in the market (such as the pandemic). We looked at 5 of the main reasons why venture debt is becoming more popular.
1. Less Expensive than Venture Capital
Venture debt involves less equity dilution making it less expensive than venture capital. By retaining greater ownership of a business, founders and existing shareholders get more of the profits at the sale of the company. Another reason it’s less expensive in the long run is that since venture debt is a loan, the interest on the venture debt is tax deductible, causing a reduction in your taxable net income. As a result, the actual cost of borrowing is less.
2. Venture Debt is Non-dilutive
Companies can benefit from venture capital investors because they bring their expertise, but in return, they receive a share of your company. Compared with equity deals, venture debt structures usually involve very little dilution. This means founders do not have to give up any stake in the direction of the business or its earnings beyond the loan term.
3. Flexible Options
Just as with traditional loans, there are different types of venture debt to consider, depending on your business needs. There are term loans, lines of credit, and convertible loans.
One of the most common forms of venture debt is a growth capital term loan. These are fixed-term loans that typically have a two-to-three-year repayment period. The funds may be released all at once, or in installments, giving you some cash upfront and the rest later to manage interest expense and debt load as the company grows.
With lines of credit, it is similar to having a credit card line for your business, which lets you borrow money at a certain limit. You can borrow the entire limit, or just a portion of it. During the early growth phase, this flexibility is crucial to financing such costs as hires, overhead, and daily operations.
Another option for companies is to use a convertible loan, a type of short-term debt financing. It’s called convertible because rather than being repaid in principal and interest, the investor gets paid in equity. The company gets capital, and the debt “converts” into equity, usually at an event such as the close of a financing round or an IPO.
4. A Safety Net for Businesses
During Covid many businesses found themselves faced with labor shortages, as well as rising costs for materials. Companies that used venture debt could ride out some of this uncertainty without having to wait until the next equity round.
Capital raised from venture debt can be used in a variety of ways including as a buffer when unexpected expenses arise, or when the company doesn’t reach a milestone. It can be used to purchase needed equipment, inventory, or cover unforeseen costs that weren’t part of the original budget plan.
5. Less Time Raising Funds, More Time For Your Business
The process of raising a venture capital round involves time for research, putting data together, scheduling multiple meetings, and pitches, which can add up to months of time. Venture debt financing, on the other hand, takes less time to process.
You save time once you receive the cash since you don’t have to consult with the lenders every time you need to make a decision. For instance, you won’t have to have the board approve every new hire or major purchase, giving you more time to run your business and make it profitable.
Before the pandemic venture debt was already on its way to becoming a popular option for businesses to get capital. After the pandemic when businesses had to adapt quickly or close altogether, it led to an increase in the creation of new companies. These investments led to more opportunities for companies to use venture debt along with venture capital to strengthen their businesses in fast growth mode. The pursuit of venture equity is expected to increase significantly this year, and we’ll see more companies turn to venture debt for growth.
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