Startups are always in the dire need of finance for the growth and development of their business. Such companies do have a history of operation but still lack sufficient positive cash flows to become eligible to obtain conventional loans. It is when venture debt comes into the picture.
It is considered the best option for start-ups to raise venture capital to build their business. This article is all about the working of venture debt financing.
What Is Venture Debt?
Venture debt is defined as the type of non-convertible, senior secured loan or debt financing offered by the financial and non-financial institutions designed for the early-stage start-ups and companies with venture capital backing.
It is raised by the majority of venture-backed companies as the viable alternative to equity venture financing.
Uses Of Venture Debt Financing
Here are some major uses of venture debt financing:
- Protecting Equity Dilution: Similar, to other methods of debt financing, a key advantage of this particular method of financing is preventing the further dilution of the equity stake of existing investors of the companies.
- Financing Capital Investments: The businesses for which bank financing is not a viable option depending on venture debt to finance the company’s capital expenditure and business acquisitions.
- Financing working capital mismatch: Another usage of this method of debt financing is to finance the working capital requirements of a rapidly growing start-up.
- Extending Runway Between Rounds: Debt is oftentimes used by the companies to extend the runway between equity rounds which leads to the higher capital raising ability in the future.
- Create A Credit Track Record: Businesses can easily build a steady credit track record at an early stage by deploying a healthy capital mix of debt and finance.
Venture Debt Financing Parameters to look at before Investing
The following mentioned are the parameters that the venture debt funds look at before investing:
Certain key parameters related to the business and the industry are analyzed by the funds to arrive at investment decisions:
- The strength of the founders and key management personnel, including domain expertise, vision, ability to build robust teams, etc.
- The quality and willingness of the investors to support the company.
- Established revenue model and healthy margins of the high-growth companies.
- Market opportunities of the businesses.
In addition to the business parameters, the following mentioned operational parameters are also analyzed by the funds:
- The liquidity position of the companies.
- The corporate governance framework of the company.
- Protocols are set by the company to maintain data integrity.
- Scalability of the working relationships.
The working of venture debt is completely different from that of conventional loans. Not only does an investor earn a considerable amount of fixed interest but also equity upside through warrants. This high-yielding combination of returns is what makes venture debt financing a lucrative option for investors.
Venture lending is oftentimes seen as the higher returns for higher risks and therefore, according to the experts it is recommended to invest wisely in this particular type of debt financing.