When and How to Use Venture Debt to Fuel Startup Growth

How and when to use venture debt

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Startup companies play such an important role in driving the Canadian economy – Entrepreneurship solves new problems, drives new spending, and creates new jobs. As exciting and adventurous as that sounds, there’s so much more to being a successful startup than just solving a problem, developing a new product, and marketing that product to the masses. Raising capital is one of the most challenging aspects of starting and growing a new business.

Entrepreneurs really have two options to satisfy their capital needs: There’s equity financing or debt financing. Equity financing is the cornerstone of funnelling capital into a company. Basically how it works is the current owners sell a piece of the company in exchange for a certain amount of money. The process can be repeated as many times as needed until the company turns cash-flow positive or is sold.

Venture debt, or venture lending, refers to debt financing products for companies in early and growth stages. It is a form of start-up financing that is halfway between venture capital and traditional loans. Lenders provide capital in return for principal and interest payments. Some contracts may also give lenders the right to invest in a future equity round. The key to debt, as compared to equity, is that the founders don’t give away ownership in their company.

So, what’s the difference between venture lending and a traditional bank loan? Unlike traditional bank loans, venture debt is available to startup companies without positive cash flow or assets to use as collateral. With a traditional loan, lenders usually ask for tangible assets to use as collateral. They also require a track record of positive cash flow. Let’s be honest, most startups don’t have either of these. Venture lenders take a dramatically different approach. They look at the quality of the technology that is being produced, market opportunities, the management team, investor syndicate, etc. They take a more holistic approach to lending and look at what could be in the future, as opposed to lending based only on what you have now.

There is really no one-size-fits-all approach to venture debt – The whole purpose is to support the growth of a startup company with low-cost capital.

There are three main types of venture debt:

  1. Growth capital is usually a term loan, secured by the company’s assets. It can be used for almost any purpose, such as to replace or augment an equity round, finance M&A activity, or provide additional working capital. Long-term growth capital loans also exist. Growth capital is available to companies that have already raised a seed round.
  2. Accounts receivable financing and/or inventory lines allow startup companies to borrow against their account receivable items or inventory. Entrepreneurs can typically borrow 80-85% of the value of these ‘working assets’.
  3. Equipment financing is used to purchase equipment such as network infrastructure, manufacturing, equipment for research and development (R&D), etc. It’s basically a lease that uses the equipment itself as collateral.

So, what are the main things companies use venture debt for?

  1. To enhance equity returns, or even replace equity financing altogether. A company may be on a clear path to profitability, but not in a place to raise another equity round. Venture debt can extend the company’s cash runway to achieve the next milestone prior to their next equity raise, resulting in a higher valuation and less equity dilution. Venture debt can be used to protect your company from potential mishaps or delays, eliminating the need for an emergency bridge round. It can be your company’s cushion to cover the gap until the company gets back on track.
  2. To fund large expenditures without depleting the company’s cash balance.
  3. To get the company through a tough period. Sometimes you just need to get through a dry spell without putting out a negative signal.

Many high-tech companies – including Spotify, Uber, Trulia, Facebook, Etsy, DocuSign and Google – have used venture debt to finance various stages of their growth.

Venture debt financing is a fantastic solution when you do not qualify for a regular loan or line of credit and you don’t want other people to make strategic and tactical decisions for your company. There are many companies specialized in venture debt financing, so if you are an entrepreneur with a great idea, venture debt may be the funding solution you’re looking for.

Contact us for more details on non-dilutive venture debt and tax credit consulting services (SR&ED). Venbridge’s services allow you to maximize your government tax incentives, better manage cash flow, and invest more in the areas you need.

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