Congratulations, you’ve just landed $15 million in Series A funding. Through the deal, you’ve moved a percentage of your startup’s equity to venture capitalists (VCs). After a few months you re-evaluate some of your spending projections and realize that while the $15 million provides a nice runway you’d failed to factor in funds for equipment you’re going to need to take operations to the next level. What do you do now? You can further dilute the company with more traditional equity-based funding or turn to what’s called venture debt. “Venture debt is a debt offering in which a fund lends a set percentage of the last equity raise,” according to an article by Howard Marks for Forbes.com. “The amount of the loan is usually around 30 percent of the last round.”As a result, your company would get $4.5 million or a total of $19.5 million in funding, enabling you to make additional investments and therefore sustain operations and growth. In this way, venture debt helps companies avoid dilution while offering extra capital between funding rounds. That’s one reason why venture debt is increasing in popularity. In fact, the market for venture debt market has almost doubled since 2016, from around $5.5 billion to over $10 billion in 2019, according to a study by Kruze Consulting.
The Upside to Venture Debt
It’s all about holding on to equity now so you can maximize your payout and upside later, according to Elliot Bohh, CEO of CardCash, in Inc magazine. “It’s about maintaining control over strategy and operations. Equity is precious. Giving it up to capitalize on a short-term opportunity, one that could be funded just as easily with debt, is a shoddy way to run a business.”With venture debt, you give up no equity, so less less dilution down the road.Plus, venture debt is well-suited for startups since you don’t need positive cash flow or collateral to get the loan.
The Downside to Venture Debt
Well, to compensate for the risk of the loan the venture debt provider includes warrants, which are options to purchase equity. If you default on terms, debt managers can call the loan and sell the company or liquidate it – although this is a limited risk – and you, the Founder, will most likely get nothing in return. In addition, the presence of venture debt can complicate subsequent equity rounds. Usually, the new investors will have to agree to repay the debt or invest below the debt. This can be seen as a negative to investors who might want to invest directly in the company. Whatever the case, venture debt offers Founders an extra option when raising funds, without the baggage that can come with venture capital and other, more costly methods.