Venture debt or venture lending (related: "venture leasing") is a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund working capital or capital expenses, such as purchasing equipment. Venture debt can complement venture capital and provide value to fast growing companies and their investors. Unlike traditional bank lending, venture debt is available to startups and growth companies that do not have positive cash flows or significant assets to use as collateral. Venture debt providers combine their loans with warrants, or rights to purchase equity, to compensate for the higher risk of default.
Venture debt can be a source of capital for entrepreneurial companies. As a complement to equity financing, venture debt provides growth capital to extend the cash runway of a startup company to achieve the next milestone while minimizing equity dilution for both employees and investors.
Venture debt is typically structured as one of three types:
Venture lenders frequently piggyback on the due diligence done by the venture capital firm.
Venture debt providers are typically classified into two categories:
1. Commercial banks with venture-lending arms'
These banks typically accept deposits from the startup companies, and offer venture debt to complement their overall service offerings. Venture debt is usually not bread and butter for these providers. Debt lines from the banks start as low as $100,000 and for appropriately backed and/or companies with scale, can reach into the tens of millions in terms of facility sizes. Some players in this category are:
2. Specialty finance firms ("venture debt shops")
Commercial banks at times can be limited in the dollar size of the loans, or strict covenants attached. The venture debt firms typically provide higher dollar size and more flexible loan terms and include:
As a rule of thumb, the size of venture debt investment in a company is roughly 1/3 to 1/2 of venture capital (equity). The VC industry invested around $27B in the last 12 months. This would imply around $9B potential debt market. However, not all VC-backed companies receive venture debt, and a study has recently estimated that lenders provide one venture debt dollar for every seven venture capital dollar invested. This implies around $3.9B debt market. There are several philosophies behind the various players. As a rule, they all prefer better branded VCs backing any potential portfolio company - some are more militant about this than others. They universally will provide capital to companies still in a money loss mode, with variances around comfort on timelines to breakeven, next round of capital, recently raised equity, etc.
Since most startups tap into venture debt to augment equity, the size of the venture debt industry follows the movement of the VC industry.
Venture debt lenders expect returns of 12–25% on their capital but achieve this through a combination of loan interest and capital returns. The lender is compensated for the higher rate of perceived level of risk on these loans by earning incremental returns from its equity holding in companies that are successful and achieve a trade sale or IPO.
Equipment financing can be provided to fund 100% of the cost of the capital expenditure. Receivables financing is typically capped at 80–85% of the accounts receivable balance.
Loan terms vary widely, but differ from traditional bank loans in a number of ways:
Over time, start-ups are rewarded for achieving major milestones by an increase in company valuation. Most companies require multiple infusions of venture capital to expand and so, the optimal time to raise funds is immediately following one of these valuation drivers, resulting in less equity dilution for the same amount of capital raised.
There are three primary scenarios where venture debt can help grow the company and finance its capital needs more efficiently: