Everything You Need to Know About Venture Debt Financing

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EVERYTHING YOU NEED TO KNOW ABOUT VENTURE DEBT
FINANCING
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What Is Venture Debt Financing?
Venture debt or venture lending is only available
only to venture-backed businesses as working
capital. This type of financing is low-priced
than equity financing and is generally structured
as traditional medium-term loans, with three- to
five-year repayment periods. A companys assets
or equipment secures it. This financing is
offered based on different factors that lenders
take into account with investors such as growth
rate, business plan, and track record. Securing
capital for growth is the paramount disquiet of
emerging growth startups and due to the enormous
business startup costs startups are always
worried with financing their ventures. Securing
traditional financing is a challenging and hard
especially for startup, so instead many turn to
equity investors. Most founders are reluctant to
give up more ownership, however, which is when
venture debt financing can be a fundamental
instrument. Regardless of the growth of the
venture debt industry, yet it remains an
unfamiliar form of financing for many. It is a
type of business loan where a company assume
debt, instead of taking investors money in
exchange for equity. However, venture debt
financing is dissimilar from traditional business
loans. Here is an overview of venture debt
financing, the eligibility criteria to secure it,
and some alternative business loan types to
consider.
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How Venture Debt Financing Works?
How Venture Debt Financing Assist Startups?
In venture debt financing, the funds are not
provided by the venture capital firms, but
instead particular venture debt lenders, such as
private equity firms, traditional banks, hedge
funds, business development companies (BDCs), and
a few others in form of debt, and not equity.
This allows founders to keep the ownership of
their venturesbeing a distinct benefit of
venture capital loans. Occasionally, such loans
are issue as business lines of credit or
equipment financing.
Venture debt financing is new improved way to
secure financing as well as a key to growth. Most
business owners keep debt and equity separate
while running a business. Many successful
startups like Airbnb, Genentech, and Uber
confirmed the potential of venture debt financing
by propelling their apparent irresistible growth
paths, instead of raising more funding.
With traditional venture capital, business owner
has to give away some ownership in the company.
And, if youre unwilling to give up your slice of
equity any further, acquiring funding via venture
capital loan is your way to go.
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Benefits and Drawbacks
There are pros and cons of raising money via
venture debt financing. Besides raising equity,
raising venture capital funding also requires a
lot of time and solid effort. As a founder,
youll be restricted to how much you can spend on
fundraising. In addition, even after you raise
funding, investors requires you to meet certain
requirements before approving you more money.
Finance an equipment or inventory purchase
Finance a marketing project
Extend cash runway to accomplish the next landmark
Attains a balanced and reasonable capital
structure
Provide growth capital with little equity
reduction
Invest in a particular prospect to expedite growth
Strengthens accounts and improves cash flow
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The Drawbacks
While venture debt financing is economical than
equity financing, there are some drawbacks to it
as well
Venture debt is only available for companies that
have already raised venture capital.
Its risky for startups that are in the growing
phase
Being a senior debt, it precedence over other
unsettled debts in case you default.
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How it Differ from Regular Business Financing?
Partially, venture debt and business loans are
similarand both categorized as debt financing
options. However, there are some fundamental
differences between the two in regards to
underwriting, security, warrants, terms and
access.
Underwriting
Collateral
Warrants
Access
Costs
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Underwriting
Unluckily, Startups dont have such credentials
for lenders to underwrite. Lenders use different
values to judge startups for venture debt
financing qualification, and to determine their
repayment terms. And, this is where their
investors come in.
The lenders underwrites a loan depending on the
investors track records, their commitment in
preceding financing rounds, along with how much
funding the company has raised generally, with
additional factors like companys business plan,
technology value, workforce, and capital strategy
as well.
While applying for a business loan, the lender
examines borrowers business and personal credit
score, before making a decision. In addition,
they thoroughly review the business cash flow,
revenue, and debt-service coverage ratio to
conclude the financial health in order to
understand whether youll be able to repay the
loan or not.
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Warrants
Collateral
Stock warrants is another feature of venture
capital loansenabling holders to buy stock at a
price indicated by the strike price on the
warrant, till a certain expiration mentioned
period. These warrants serve as financial
incentive for the venture capital lender. These
warrants serve as an incentive to lenders in
exchange for their money.
For a regular business loan, collateral comes in
the form of real estate, savings, equipment or a
blanket lien. For venture debt financing, lenders
also place blanket liens on companies. Sometimes,
an absolute pledge to the companys trademark is
serve as collateral, especially when the lender
considers it as likely very risky.
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Costs
The terms and costs of regular business financing
options vary from the venture capital loans. The
U.S. Small Business Administration (SBA) loans
are perhaps the most sought-after business
financing option that are backed by the federal
government. The SBA loans offer the lowest
interest rates and longer repayment terms in
comparison to other loan options. But, they are
only available to qualified borrowers with high
credit scores and solid business financials. The
maximum rate of interest is 2.75 Prime Rate
for SBA 7(a) loan and 5 to 6 interest rate for
SBA 504/CDC loan. For venture capital loans from
banks, the costs is Prime Rate 0 to 4, and
from hedge funds, the costs is Prime Rate 5 to
9.
Access
Venture debt financing is not issues by the
capitalists and venture firmsinstead venture
debt lender, like a bank or a hedge fund, issues
it. Most startups arent venture-capital backed,
therefore they dont have access to venture
lendersand also dont have the needed
underwriting credentials for venture capital
lenders.
VIEW WORKOUTS
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Best Financing Alternatives to Venture Capital
Loans
Venture capital loans are not viable financing
options for most startups. There are some
alternatives to venture capital financing, which
are listed below
SBA Loans Revenue-Generating Startups
Asset-Based Loans For Specific Purchases
Business Lines of Credit For Early-Stage
Startups
JOHN DOE
Personal Loans For Pre-Revenue Startups
0 Introductory APR Business Credit Cards For
Planning Stage Startups
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SBA LOANS For Revenue-Generating Startups
The U.S. Small Business Administration (SBA)
offer loans by guaranteeing up to 85,
eliminating risk for their partner lenders. This
also allow lenders to offer lower rates, higher
loan amounts, and longer repayment terms.
However, qualify for SBA loans is hardtheyre
only available to borrowers with great credit
histories and solid business financials. SBA also
offers a microloan program to help finance
startups, with loan amounts up to 50,000. This
loan program is specially designed to help
business owners who are much like in the venture
capital ecosystem (minorities, people of color,
and veterans).
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BUSINESS LINES OF CREDIT For Early-Stage Startups
Startups dont have the needed credentials like a
time-in-business, revenues, and a business credit
score to prove their creditworthiness for a
business loan. Thats reason most lenders will
not willing to work with early-stage startups on
business loan products. Nonetheless, all you
have is a personal credit score, business bank
statements, and a basic documentationand for
some lenders, thats adequate to approve you for
a business line of credit. A credit line is a
great financing option especially for early-stage
startups. It works similar to a business credit
card, where youre provided with a pre-approved
amount of funds to draw as and when required. And
the best part you only pay interest on the funds
that you use.
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ASSET BASED LOANS For Specific Purchases
If you need funding for specific purchases like
new equipment, inventory, or supplement cash
flow, asset-based loans can help. Asset-based
loans are easily accessible for early-stage
startups, since theyre self-secured. The asset
you purchase from the loan will actually serves
as collateral. With that said, if you default on
an equipment loan, the lender will seize the
equipment and liquidate it to recoup its loss.
Equipment financing and Invoice Financing are the
most pertinent types of asset-based loans.
Though, these loans are accessible easily,
lenders still review your credit score and
business financials. Due to the built in
collateral, the risk is much lower for the
lender, so you dont have to have a solid credit
or financials in order to get approved.
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PERSONAL LOANS For Pre-Revenue Startups
Putting personal money into the business makes
sense for most startups. In fact, many founders
across all industries that are pre-revenue and
spending cash, consider putting their own money
into their business with a personal loan. The
only thing worth considering is to build a
separate business credit history and business
bank account while your personal loan is
unsettled. Make sure to repay your bills on time
and in full via a credit card to establish
business credit.
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0 Introductory APR Business Credit Cards For
Planning Stage Startups
First things first, apply for a business credit
card in order to build business credit, in order
to get eligible for business loan products.
Applying for a 0 introductory APR business
credit card is the most suitable option for early
stage startups. Having these cards mean you carry
a balance for a predetermined period without any
interest until the period is overmaking it an
interest-free loan. There is no minimum time in
business requirement as long as your personal
credit score is solid enough to qualify.
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When Venture Debt Isnt A Viable Option?
Financing a startup is challenging, and requires
a lot of preparation and planning. With so many
business loan options availableespecially when
venture debt financing isnt accessiblethere is
a comfort that you can still finance your
startup. The above-mentioned alternatives are
great financing options for startups and some are
structured alike venture capital loans,
nonetheless. This goes without saying, the best
things grow little by little over time.
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