Venture Debt - The Complete Guide

When startups are ready to take their business to the next level, access to capital is critical to their growth. Venture debt is a financing option for businesses in early growth stages and often a first source of institutional funding for emerging companies.

While there are many benefits to venture debt, this type of financing is only available to certain kinds of businesses. In this guide, we will walk you through how venture debt works, which businesses benefit from it and how venture debt compares to other financing options in the marketplace.

How Does Venture Debt Work?

One of the biggest challenges for startup companies is to take their business from the inception of the brand to profitability. During this time period which can span over multiple years, many companies experience negative cash flow and need multiple infusions of cash to expand.

Venture debt is an effective way for tech startups with venture capital investors to fuel growth after an equity raise. It extends the cash runway for brands during times of high growth and between raises until they become cash flow positive. It can also serve as a cash cushion for when things don’t go as expected and cash is needed to bridge the slower months.

A technology lender will provide this type of loan after taking a look at the life stage of the company as well as its capital strategy. For businesses with little operational history, lenders will take a closer look at the details of past equity raises and the potential of the innovation that drives the company to determine loan price and terms. Through venture debt, startup companies gain access to much needed growth capital to take things to the next step until they reach profitability.

Differences From Other Forms of Credit

Venture debt comes into play between various equity raises of a startup company and complements equity financing. An important differentiator of debt financing is that it is less dilutive than equity as well as other financing options that require a percentage of equity in return.

One of the main differences is that most commercial banks do not provide venture debt financing due to its high risk and other regulations and specialize in other forms of credit. Technology lenders and venture capital firms provide this sort of financing to startup companies instead specializing in venture financing.

The Benefits of Venture Debt

Venture debt can be a great way for businesses to extend their runway to reach new milestones and take the business to the next level. By providing growth capital, businesses gain access to the necessary funds to expand while minimally diluting equity. Debt financing also allows for smaller equity raises along the way and ensures a higher evaluation of the next raise. With multiple rounds of equity and debt financing, companies can bridge the way to profitability.

An additional benefit of venture debt is that managers and employees benefit from less equity dilution that comes with venture debt financing. This especially pays off once the company reaches a certain size and monetary value in the future. Equity financing is much more dilutive and stakeholders would see an increased loss of ownership.

Businesses Where Venture Debt Make Sense

Venture debt makes sense for startups that are backed by investors with venture capital and where the path to profitability is clear and predictable. It is primarily a great fit for companies in the tech, life sciences and innovation industries. Throughout various growth phases, startups experience negative cash flow and need extra capital to reach their next milestone after an equity raise. Due to its minimal dilution, venture debt is also a great alternative to the last round of equity financing (Series C) as it helps retain more ownership than an additional equity raise.

Another scenario where venture debt makes sense is gaining access to extra capital as a way to cushion out periods of time when things do not go as planned to increase the company’s valuation before the next equity raise.

Venture Debt Timing

The ideal time for venture debt is following an equity raise or between equity rounds. This happens ideally a few months after a new round of equity. Creditworthiness and the ability to bargain on a loan is often highest right after a cash infusion and should be taken advantage of.

It is important to keep in mind that the venture world is cyclical in nature: The availability of this type of funding often depends on the trends in the venture capital industry.

Venture Debt Terminology

Here are the most important terms brands should know that are related to venture debt:

Venture debt: A type of loan provided by bank and non-bank lenders for startup companies with venture capital backing.

Venture capital: financing provided by an investor for companies with predictable long-term growth potential

Equity dilution: This occurs when the company gives out new shares to investors and results in a decrease in equity ownership of existing shareholders.

Equity raise: Raising capital by issuing equity to investors

Valuation: The estimated value of a company at the time of an equity raise.

Looking for Alternatives to Venture Debt?

Although venture debt can be a great way to fuel growth, it is not a one-size-fits-all solution. Especially companies that are not rooted in the tech, life sciences and innovation industries will likely not be able to procure venture debt financing.

The good news: There are other non-dilutive financing options available to brands that are tailored to the needs of emerging e-commerce brands in the consumer goods space. Assembled Brands provides capital solutions like working capital loans and e-commerce funding besides an unrivaled network of high-growth brands that can be leveraged to make meaningful connections.