Reading time: 5 minutes
Venture debt makes up almost 10% of the venture capital market. And with the market for venture capital growing tremendously – US$75.6 billion invested globally across 9100 deals in the third quarter of 2019 alone – it’s no surprise that venture debt itself is also growing with it.
As an alternative to traditional debt financing, venture debt can be used by venture-backed start-ups, SaaS companies, and even fledgling manufacturers to build up company assets, have greater financial flexibility, and fix cash flow issues, among other problems.
The Idea Behind Venture Debt
It’s simple – your company needs additional capital to support its needs and there are lenders enthusiastically looking for promising start-ups to invest in. They offer you additional capital in the form of debt so you can avoid further dilution you likely faced in the seed round of start-up funding.
For example, you raised $600,000 during the seed round, where you were valued at $3,000,000 and then managed to raise another $10,000,000 Series A while your valuation was at $30,000,000.
You’ve given away a significant percentage of your shares to your investors by now and want to save further dilution. With venture debt, you can raise funds for re-invest in R&D, accelerate product development or invest in sales and marketing without having to dilute ownership further until you get to your Series B.
How Venture Debt Works
Your lender – bank or non-bank – gives you a loan secured by non-traditional assets such as grants, tax credits, or your monthly recurring revenue as collateral. Lenders, naturally, want to safeguard their interests as well, so you’ll also have to account for:
- Cost to borrow the money
- Cost while the money is loaned to you
- Cost to exit the loan
A venture debt facility could also feature an initial period where you only pay interest only or even a complete payment holiday. If it’s a term loan backed by your tax credit, the loan will be paid when you receive your refund.
But it’s worth it because you get funding for your business, which, if spent wisely, will help you get closer to your long term or immediate goals and get you to a higher valuation for your next round of funding.
Common Reasons For Start-ups To Use Venture Debt
Here are a few reasons why start-ups opt for venture debt:
Tech start-ups trying to overcome a cash crunch
Any company can face a cash flow problem and 82% of small businesses fail because of it. For tech start-ups, a cash crunch occurs when certain obligations take up too much of their financial resources, leaving very little behind for day-to-day operations.
Maybe your company gave out a little too much on developing a new product, or you lost on a major client leading to an unexpected cut in revenue, or a new feature on your app took too long to roll out and that consumed a lot of your resources.
While raising equity to overcome these problems can be time-consuming, venture debt can ease immediate financial pressures within days.
SaaS companies investing in growth opportunities
If you want to scale your SaaS business’s operations and expand its customer base, you simply need money to pump into sales and marketing. A lack of financial resources may hold you back.
Acquiring fresh talent and increasing your marketing budget to accommodate for greater ad-spend can be financially and practically challenging, for example. In fact, a report suggests 63% of all start-ups are affected by a lack of talent in their workforce.
Using venture debt to raise finances for hiring sales talent and increasing your customer acquisition investment can be a clever decision as you make your way to increased profitability in the long run.
Extending The Cash Runway For Start-Ups
Venture debt gives rising start-ups like yours a boost in valuation so you’re in a much stronger position for the next institutional equity round. Extending your cash runway to deal with operational expenses is an integral part of that.
You can quickly tick all boxes for critical metrics to enter your next equity round with your confidence peaking.
Additionally, venture debt can also work as growth capital for your business when you need enough room to pivot your business model – think strategically for your long-term interests by planning, testing, and implementing new processes.
Tech Companies Investing Heavily In R&D
Canadian companies investing heavily in research and development may be eligible for the Scientific Research and Experimental Development (SR&ED) tax credit. However, even if your company is qualified, you may have to wait for more than a year to get your tax refund and even longer to reinvest it wisely. If you’re developing technology, having to wait to roll out a new product amplifies the risk of technology decay.
With SR&ED financing, your company can finance the tax credit on a quarterly basis as it accrues, and pump it directly into your R&D efforts instead of having to wait a whole year or more for the SR&ED refund.
Manufacturing Companies Trying To Meet A Large Order
New manufacturing businesses operate on a day-to-day basis. So, It can be difficult for them to fill out large immediate orders because of a lack of resources. If finances are a problem, venture debt can be the solution.
- Need to pay for raw materials?
- Need bulk transportation for the finished product?
- Need to finalize product development and scale production faster?
Venture debt finances your needs faster than equity as it can be finalized in as little as three to business.
In A Nutshell
All in all, venture debt addresses the concerns of many growing businesses. Depending on what stage your company is at, what your long-term goals are, and the industry you work in, it can be worthwhile to add venture debt to your balance sheet.
Do you have a startup in Canada that needs funding to grow? We can help you, contact us now to discuss how non-dilutive venture debt can help scale your company’s operations.