Venture debt has been gaining popularity as a way to extend cash runway for a business. It supplies much needed funding for fast-growing companies looking to scale and continue to grow. Often these companies are on target to be profitable, but they need the capital to keep things running and to invest in resources to get it to the next level. When considering debt finance vs equity finance, both venture debt and equity financing provide capital to businesses, but they differ in a few ways.
Let’s take a look:
Venture Debt Minimizes Equity Dilution
Capital raised from venture debt is based on a company’s potential growth, so a company doesn’t have to give up ownership and dilute their equity. Rather, venture debt financing is a type of loan with interest that has to be repaid. While venture debt loans can involve warrants, the impact on dilution is often much less than equity financing.
When you raise capital through equity financing, it involves selling shares of the company’s stock, meaning the current stockholders now own a smaller percentage of the company.
Venture Debt Allows Companies to Retain Control
One advantage of venture debt financing is that once you pay the loan back, your relationship with the lender is complete. While there are venture debt providers that offer advising services, more often than not they have no involvement in your company’s business decisions.
Equity financing, on the other other hand, involves selling a stake in your business in return for their cash investment. Since the investors are contributing the capital and have a stake in the company’s growth and profitability, they are often involved in discussions about the company’s business strategy. Advice provided by investors can be valuable for growing companies, but there is a risk that the advice may be different than the founders’ original direction.
Getting Capital Faster
Another difference between venture debt and equity financing is with the time it takes to actually get the capital. For venture debt deals, from the initial proposal and paperwork, it usually takes about 3 months to get funding.
Equity financing can take much longer. Your company will need ample time to do research, prepare your pitch deck, find the right investors, complete documentation and paperwork, and go through negotiations. Depending on the size of the deal and other factors, the time involved can be shorter, but most companies should expect it to take up to six months.
Cost of Debt vs Equity
Since venture debt is a loan with interest, and these payments are considered a business expense, the payments are tax-deductible. This will reduce your net tax obligation at the end of the year. The investment from venture debt (including interest) is a fixed amount over the life of the loan.
With equity financing, investors get a proportion of the profits, based on their stock holdings. This amount can be much higher than the initial investment at exit. If the value of the company goes up, so does the percentage of the sale that would have otherwise gone to the company founders.
Venture Debt and Venture Capital Work Together
Venture debt doesn’t replace equity financing, it can be used with equity financing to invest in technology or new products to fund future growth. Companies can raise venture debt soon after a round of equity to help to get the company where it needs to be to be. As a result, certain milestones are reached more quickly and founders maintain significant control of the company without losing significant value to investors.
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