How Does Venture Debt Financing Work?

There are numerous of financing options out there, but you need to do your research and weigh the pros and cons of each. Typically, startups face challenges with securing small business lending, so many will turn to equity investors instead. Venture debt financing is a business loan in which a company will take on debt, rather than accepting money from an investor in exchange for equity.

What Is Venture Debt Financing?

Venture debt financing is debt a startup takes on in the form of equipment the business requires. Venture debt is usually less expensive than equity financing and differ from traditional small business loans. It is short-to medium-term and involves interest payments. The payments are based on either the prime rate or LIBOR, which is another interest rate benchmark.

What do Venture Lenders Look for?

It is helpful to understand what venture lenders look for if you are considering venture debt financing. Although everyone will have different criteria, below are some guidelines.

  • Size: in certain cases, venture debt firms require a minimum annual revenue of at least $200,000 to $1 million.
  • Revenue: predictable revenue is preferred.
  • Growth: historical and projected growth need to be positive.
  • EBITDA: business should be cash flow positive or close to it.

Pros and Cons of Venture Debt Financing

Pros of Venture Debt

Venture loans are helpful when you need to:

  • Extend cash runway between rounds
  • Finance a project
  • Finance a purchase such as equipment or inventory
  • Invest in a specific opportunity to accelerate growth
  • Limit dilution of ownership and you can grow your business without giving up voting shares or equity

Cons of Venture Debt

  • It is costly
  • Need consistent cash flow to make the payments
  • If you default on the loan, the debt takes precedence over other outstanding obligations
  • Venture capital lenders can seize control of your company or its assets, or force to liquidate it if you default
  • It is the only option available to companies that raised venture capital
  • Hard to qualify without an existing credit history.

How to Select a Lender?

You should talk with several lenders so you can compare pricing and terms. It is also important to find out if the lender has a good reputation for working with borrowers and that they have experience.

Capital can be obtained through banks or specialty finance firms. Banks have less expensive capital, but their loan size is constrained due to regulatory requirements. Specialty finance firms are more expensive but less constrained.

How to Apply for a Venture Debt Loan

If you have decided you want to apply for a venture debt loan, the process below will help you during the application process.

Being prepared is key to securing any type of loan because you want to present to the investors your solid business plan. Any information that shows how the loan will impact the company’s growth will be needed in your business plan. The other points you should have prepared are:

  • Your business model
  • The defined roles for the positions of your staff
  • Your market research
  • Details about your product or service
  • Your marketing strategy
  • Your target audience

The Bottom Line

By now you should have a better understanding of what venture debt financing is and if it something that is going to benefit your business. If you find that you do not qualify for it just yet, do not be discouraged because there are plenty of other types of financing solutions available for you. If you decide to move forward with venture debt financing, follow the steps in this article to help you achieve approval.