Is Venture Debt Financing Right for Your Business?

Startups face numerous hurdles on their way to success, even if they have strong venture capital. You might not have the sales projections and credit history needed to get a traditional business loan. In this post, we will review what venture debt financing is, so you can figure out if it is the right solution for your company’s capital constraints.

What Your Business Should Know About Venture Capital

You might be eligible for debt financing from other venture-specific banks or vc firms. Venture capital financing is all about equity and milestones. If your company is developing a new piece of computer hardware, one typical early-stage milestone is completion of a prototype.

When the milestone is reached, equity financing is triggered as the company’s value is increasing. If your company is struggling to hit the milestone needed to secure another round of growth capital, venture debt can bridge that financing gap without diluting ownership.

There is risk of being involved lending to companies with minimal revenue, venture loans can come with stipulations called covenants.

What Are the Disadvantages of Venture Debt Financing?

Venture debt financing is not suitable for founders looking to avoid dilution. Venture debt financing is expensive because you will pay for beyond what you would for a traditional term loan through the SBA. Venture debt can come with stipulations.

If you cannot meet the obligations for the loan, venture debt financiers could re-negotiate the deal to take equity away from the founders. Venture debt is also senior debt, meaning it gets repaid before anything else during a liquidation event.

The venture debt lender will want warrants, which can be converted to equity if the company goes public or is acquired by another firm. Warrants are usually priced according to the most recent round of equity financing.

What Are the Benefits of Venture Debt Financing?

Despite the drawbacks, venture debt can still be a great option for some companies. Venture debt can make sure operations run smoothly for your business if you need a cash flow infusion to reach a milestone in equity financing. You should have a specific reason for doing it such as needing equipment financing or having significant cash in your accounts receivable.

If your company has a low cash burn rate, venture debt financing is appealing for your business. You will get access to more working capital without surrendering equity and the chances of default will be minimal.

The Bottom Line

You will have to consider several variables before acting, venture debt financing is not right for everyone. Venture debt supplies between 20 to 30 percent of the equity raised in the previous equity round so make sure you are getting enough cash to get it worthwhile.