Venture debt or venture lending refers to a variety of debt financing products offered to early and growth-stage venture capital-backed companies. It is a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund working capital or capital expenses, such as purchasing equipment. This type of debt financing is typically used as a complementary method to equity venture financing.
Venture debt can complement venture capital and provide value to fast-growing companies and their investors. It can be provided by both banks specializing in venture lending and non-bank lenders. Unlike traditional bank lending, venture debt is available to startups and growth companies that do not have positive cash flows or significant assets to use as collateral. Venture debt providers combine their loans with warrants, or rights to purchase equity, to compensate for the higher risk of default. Similar to other methods of debt financing, a primary benefit is preventing the further dilution of the equity stake of a company’s existing investors, including its employees.
When structured appropriately, venture debt can be an attractive financing option for the following reasons:
- It results in less equity dilution for entrepreneurs and investors.
- It does not require a valuation to be set for the business.
- Venture lenders do not require board seats.
- The due diligence process is typically less exhaustive compared to equity.
Venture debt works differently from conventional loans. The debt is short- to medium-term in nature. The principal amount of debt is usually determined using the amount raised in the last round of equity financing. Unlike traditional bank lending, venture loans are catered towards startups and growth companies that do not necessarily have the positive cash flow or hard assets to use as collateral. The commonly acceptable principal amount is 30% of the total funds raised in the last round of equity financing. The benefits of taking a venture loan are to provide funds to accelerate growth, achieve higher valuations and/or cushion for the unexpected.
Venture debt can be a source of capital for entrepreneurial companies. It is usually provided to startups that have already successfully completed several rounds of venture capital equity fundraisings. As a complement to equity financing, venture debt provides growth capital to extend the cash runway of a startup company to achieve the next milestone while minimizing equity dilution for both employees and investors. The financing is primarily used by such companies to reach anticipated milestones and to acquire the capital assets that are necessary to achieve them.