Startups and entrepreneurs need capital to support their businesses at a reasonable cost. At a time when venture capital funding is slowing down, venture debt funding is growing and gaining popularity among tech startups and entrepreneurs.
Venture debt, also known as “venture leasing,” is a form of a loan provided by either a bank or a non-bank lender to fund a company’s working capital or capital expenses. Unlike traditional bank lending, venture debt is a smart option for startup and growing businesses that lack the assets or cash flows for traditional commercial financing, but are equity-backed by one or more big institutional investors.
There are two general types of venture debt available in today’s market:
- Equipment financing, which is used specifically for purchasing equipment and is secured by that equipment alone;
- Growth capital, which refers to term loans that can be used for expansion or restructuring of operations and are secured by a blanket lien on the company’s assets.
Venture debt is used to complement equity financing, a form of “risk capital,” which, when structured appropriately, can reduce costs, enable the startup to achieve its next significant milestone, and increase the valuation of the company. Additionally, it can lower ownership dilution from new investors and either extend company’s runway or accelerate its growth. It also allows equity investors to reserve additional capital for future rounds.
Otherwise, if it’s used poorly or with unfavorable terms, venture debt can lower a company’s agility or become an obstacle to future equity raises. The unfavorable conditions for venture debt could be:
- When the company is already at a low cash balance or uses it as a last resort for financing;
- When the debt payments will be more than a quarter of the company’s operating expenses;
- When the company has highly stable revenue streams and receivables, since a line of credit tied to accounts receivables is likely to be more appropriate and cheaper than venture debt funding.
In today’s marketplace, besides venture debt financing, the only viable alternative option to procure IT CapEx and reap the benefits of a true OPEX, is a proprietary service provided by M-Theory Group, known as CaaS™. M-Theory Group’s trademark, CapEx-as-a-Service™ (CaaS™), changes any IT CapEx purchase into a monthly managed OpEx subscription, blending the benefits of both consumption methods and making the IT an enabler for businesses. Unlike venture debt financing, CaaS™ doesn’t require any additional security instruments, warrants or stock options.
In conclusion, despite the fact that venture debt is a strong, viable option for venture-backed tech startups who want to increase capital, minimize dilution, and be flexible, the most important question remains whether the proposed funding tool meets the company’s financing goal.