Historically Venture debt checks were on the smaller sized specifically for start up. Larger firms didn’t play in this arena. But as startups have grown, so have their borrowing needs. Venture Debt is now attracting bigger players in private equity such as Blackstone and KKR. A decade ago, venture debt topped off at $10M, now they can reach hundreds of millions and significant investors.
Many of the biggest players in the world of alternative finance noticed in recent years that lending to unprofitable startups could be surprisingly lucrative with relatively lower risk than many in the industry had assumed.
What is Venture Debt
Venture debt is a type of debt financing obtained by early-stage companies and startups. This type of debt financing is typically used as a complementary method to equity financing. Venture debt can be provided by both banks specializing in venture lending and non-bank lenders. Venture debt is frequently used as an alternative to equity financing instruments like convertible debt or preferred stock.
Venture debt is usually offered to companies that have already successfully completed several rounds of venture capital equity fundraisings. These are typically companies that have some history of operations but still do not have sufficient positive cash flows to be eligible to obtain a more conventional loan.
Most venture debt instruments involve interest payments only, as opposed to principal plus interest. The payments are based on either the prime rate or another interest rate benchmark.
In addition, in venture debt financing, the lenders often receive warrants on the company’s common equity as a part of the compensation for the high default risk. The total value of the distributed warrants generally represents 5% to 20% of the principal amount of the loan.
One of the reasons venture debt is commonly used by venture capital investors is because of its higher liquidation preference. This limits the risk investors take on since there is a higher likelihood that they will be paid than if they owned common shares in the company.
Article by: Rakesh Parikh
Rakesh is a Managing Director and founding member of Pivot Capital LLC. As a registered certified public accountant, he’s spent the past 20 years in private practice as the founder of One Capital Financial Advisors, Inc. advising clients in accounting and financial services including audits, reviews, compilations, valuations, tax advice and LLCS corporate preparation. His work also includes mergers and acquisition advisor, certified exit planning advisor to small business and family partnerships as well as due diligence in buyer-side target acquisitions.