Finding the right business funding can be challenging for even the most established business. Those challenges multiply when you have a startup business that lacks revenue, business credit history, or collateral. For many startups, simply visiting the neighborhood bank to get funding isn’t realistic, leaving many startups without funding or embracing lenders with high rates of interest, low borrowing amounts, and short repayment terms.
Why get caught in a cycle of debt when you don’t need to? Whether you own a startup or you’re prepared to begin but a lack of funding is holding you back, you do have other options. In this article, we’re going to take an in-depth take a look at one of these options: venture debt.
Is venture debt something you’ve been considering? Or maybe it’s a totally new concept. In either case, we’re going to break up what venture debt means, how it operates, and help you decide whether it’s the right choice for funding your startup.
What Is Venture Debt?
Type the phrase “venture debt” to your search bar, and you’ll be inundated with definitions that make you scratching your face. Rather than using technical terms, we’re going to break everything down throughout this post so it’s simpler to understand.
Venture debts are a kind of debt financing. This means that borrowed money is repaid over a period of time set through the lender. In addition to repaying borrowed funds, the company also pays interest. While this may seem similar to traditional business loans, there are some differences that we'll describe in more detail just a little later.
Venture debt is best suited for startup businesses or growing firms that have already raised capital through fundraising rounds. It's obtained through venture debt lenders which include banks, private equity firms, and other investors and groups.
When & Why Businesses Use Venture Debt
As mentioned in the previous section, venture debts are primarily used by startups and early-stage companies that have already raised a minimum of some capital through one or multiple rounds of funding. Some lenders even take mtss is a step further by only lending to companies that are backed by a well-known investor. In other words, even though you raise $100,000 through GoFundMe or Kickstarter out of your friends, family, and followers, this isn’t sufficient for many lenders.
However, in case your clients are backed with a known investor along with other requirements are met, you might be eligible for a this kind of funding. Now, why can you choose venture debt over another kind of funding, such as a business loan? Like a startup or early-stage business, qualifying for traditional funding is tough, if not impossible for many businesses. Banks along with other lenders assess risk before handing over money, and new business organisations haven’t yet established a good history of success. This translates to rejected loan requests or loan offers with sky-high interest rates, short terms, low borrowing limits, and additional fees that significantly enhance the cost of borrowing.
On the other hand, startups may consider equity financing — that is, the company gives up company shares in return for capital. There are benefits and drawbacks to this strategy. While it has startup businesses use of capital without high rates of interest and fees, it does take away partial ownership — meaning quitting control button of the business and full profit potential further down the road. Venture debt is a suitable alternative that lots of startups have taken benefit of.
How Venture Debt Works
Let’s have a more specific look at how venture debt works.
Reasons For implementing Venture Debt
Capital from venture debt can be used in many ways. It can be used to finance a task or perhaps an asset required to accelerate growth and assist the business become successful. Some specific ways venture debt can be used include:
- Funding long-term projects
- Making a sizable purchase, such as equipment or inventory
- Extending time between funding rounds
- Making an investment in an opportunity that will help the company grow
Repayment Terms
The rate of interest and repayment terms vary from bank to bank, but you can generally be prepared to repay your financial troubles over a period of two to four years with interest set between the best rate plus 0% to 9%.
Depending around the terms you agree to with a lender, borrowed funds might be repaid in many ways, like a period of interest-only payments accompanied by larger monthly payments or perhaps a balloon payment at the end of the repayment term.
Collateral
While many types of funding require specific collateral — physical property that can be seized when the funds aren’t repaid as agreed — this is only sometimes true for venture debt. If the funds are getting used to buy a piece of equipment, for instance, the item being purchased could serve as collateral for the loan.
However, if money is being used for any project, like a big advertising campaign, venture debt doesn’t require collateral within the traditional sense. This is when stock warrants come into play.
Stock Warrants
Venture debt allows a company to get the capital it requires for growth without diluting ownership. There's, however, an added incentive built into venture debt for lenders taking on high-risk loans by means of stock warrants.
Stock warrants receive by company that trades with an exchange. Stock warrants give the investor the authority to purchase stock within the company in a set price. The opportunity to purchase stock only at that price does have a deadline specified between the lender and also the borrower. Stock warrants really are a further incentive for lenders to take on the chance of working with startups and developing businesses.
Default
Most borrowers don’t plan to take a loan without repaying it, but unfortunately, sometimes the inevitable happens: a company isn’t creating a profit and is unable to afford paying off its debts. Should this happen, what in the event you expect from your lender?
Venture debts are also known as senior debt. Which means that your lender takes first position over other lenders or investors when it comes to liens. Now, if your piece of equipment was purchased using the capital you received, it can be seized and sold if it was used as collateral.
But let's say no specific collateral was attached to your financial troubles? It’s likely that the terms included a blanket lien, that allows the lender to legally seize then sell business assets in order to remove the debt. Oftentimes, this doesn’t just include your physical assets — it may also incorporate your ip.
This is why it’s recommended that companies that curently have financial resources and are starting on solid ground use venture debt like a source of capital. As with any other kind of economic funding, make sure that you fully understand the terms established by the lender before signing anything.
Venture Debt VS Business Loans
So, how's venture debt different from your everyday business loan? There are a number of similarities between venture debt and loans, but there are also a few significant differences between the two types of funding.
First, let’s look at the similarities forwards and backwards.
- Debt Financing: Venture debt and loans are generally types of debt financing. In other words, funds are repaid during a period of time without quitting shares of the business.
- Lender Options: Both kinds of funding can be acquired from a bank or from the non-bank lender.
- Access To Capital: One of the most obvious similarities is the fact that both types of funding give businesses use of capital to continue operations, grow, and to enhance the odds for success.
Now, let’s compare the differences between both of these types of financing.
- Requirements: To receive a business loan, banks and other lenders take a look at factors including personal credit history, business credit history, amount of time in business, and annual revenue. In some cases, collateral may be required. Venture debt lenders, however, take a look at factors such as the amount of cash raised, investors, the product/service being offered, as well as the business’s team.
- Term Length: Most venture debt lenders require debt to be paid back over a period of Two to four years, although this may vary slightly. With respect to the type of business loan you apply to get, repayment terms could be Ten years, 20 years, or even longer.
- Usage Of Funds: Venture debts are most often employed for a specific project or asset that is used to grow the company. Loans — generally — are more flexible in terms of how they’re used. Business loans can be used as capital, to employ employees, or perhaps to repay existing debt.
- Borrowing Limits: How borrowing limits are determined is another distinction between venture debt and business loans. Business loans consider things like personal credit history and debt-to-income ratio. Venture debt lenders usually base your borrowing limit on a percentage of the main city earned in your most recent round of fundraising.
- Reporting Requirements: Once you’re approved for any small business loan, the loan is simply repaid as agreed. You typically don’t have to provide more documentation to your lender unless you’re seeking additional funds. With venture debt, however, you might be necessary to report regularly to your lender through documentation for example monthly income statements, balance sheets, and tax statements.
Is Venture Debt Right For You?
With an understanding of the items venture debt means and how it really works, you'll probably still be wondering if it’s the best financial choice for your company. Before you take the plunge into venture debt, think about these factors:
- Fundraising: Perhaps you have already raised investment capital funds through one or more rounds of funding? Venture debt is ideal for startups along with other companies that have previously raised capital and will also be capable of paying off the debt. Some lenders may even require backing with a known investor or number of investors.
- Understand Risk Of Default: Venture debt is best for businesses that are increasing and need more funding to hit their next milestones. Businesses that aren’t within this position are in greater risk of default, which means that the company could be liquidated or seized through the lender.
- Know Your Terms: Getting capital through venture debt has terms much like a short- or medium-term loan. Generally, you’ll have 12 to Two years to repay the funds. If you’re searching for a funding with longer terms, consider other available choices — which we’ll go into more in the next section.
- Have A Purpose For Your Funds: Looking for working capital or don’t have specific plans for that funds you receive? Keep taking a look at other financing options. Venture debt ought to be adopted for a specific purpose, for example creating a large purchase (like equipment), funding a task, hitting a particular milestone, or growing the business without further diluting shares.
Learn About Other kinds of Financing For Startups & Entrepreneurs
Does venture debt not seem like the right fit or you’re still on the fence? Don’t worry — this kind of funding certainly isn’t best for every business. The great news, though, is you do have other available choices. While startups and new entrepreneurs may find it a little challenging to find funding, it’s not impossible, especially if you’re willing to get a little creative. Unclear about how to start? Browse the 20 How to Finance A company Startup to find out ways you can get your business off the floor — or take it one stage further. Good luck!
