By Ashok Subramanian
Funding capital for startups has been about trading equity for tranches.
However, it is good to understand that there are other options available that enable startups to increase their valuation before using equity as a bargaining chip. Venture debt is one such option (1).
According to Wikipedia (2), Venture debt or venture lending or “venture leasing” 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.
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.
One of our clients preferred this way out — as they believe that with some funding, they can increase the valuation steeply.
This results in using of debt financing to achieve certain growth targets and then when valuating the startup, it essentially gives an exit option to the venture debt financier.
As per Wikipedia (2), venture debt is typically structured as one of three types:
- Growth Capital: Typically term loans, used as equity round replacements, for M&A activity, milestone financing or working capital.
- Accounts Receivable Financing: borrowings against the accounts receivable item on the balance sheet.
- Equipment financing: Loans for the purchase of equipment such as network infrastructure.
Venture debt is an easy option, provided the startup founder’s financial credit worthiness is intact. About 30% of venture capital market looks at venture debts as a serious option (1).
This will also mean that the founders should maintain the personal financial credibility in good books. If there are issues, it is better to work and fix them, before getting into any sort of financing.
We will discuss the various types of venture debt financing in the next column — including the genesis.
Ashok Subramanian is a serial entrepreneur, business strategist and growth hacker. You can get in touch with him at email@example.com.