December 5, 2022

Venture Debts; What You Need To Know

  • by Jarrell Marley
  • 12 Months ago
  • Comments Off

It makes sense to use venture debt to supplement the equity you raise if you plan to raise institutional venture capital to develop and expand your business. A venture debt is a loan issued by banks and non-bank lenders for start-up, high-growth businesses with venture capital backing. Most venture-backed businesses obtain structured venture debt from banks and non-bank lenders such as SWK Holdings.

Breaking down Venture Debt

Contrary to traditional debt funding strategies (such as senior/secured lending), venture finance is only sometimes backed by concrete, underlying collateral security.

In general, many early-stage businesses and start-ups need to own significant assets that could be utilized as collateral. For this additional risk, venture financing lenders frequently give warrants on the company’s common stock as payment.

Companies that have completed many rounds of venture capital equity funding are typically granted venture loans.

How Venture Debts Work

Compared to more traditional loans, venture debt functions differently. Typically, the debt is of a short- to a medium-term character (1-3 years, often).

Various funding methods exist, but a general “rule of thumb” states that a venture lender may consider a loan sum of up to 30% of the business’s most recent round of equity financing. In addition, as payment for the substantial default risk in venture finance financing, the lenders frequently get warrants on the company’s ordinary stock.

Typically, 5% to 20% of the loan’s principle amount is represented by the total value of the dispersed warrants.

The warrants can be converted into common shares at a predetermined rate in the future, which could be based on the share price at the most recent equity raise or a discount to one in the future, or it could be based on both.

Types of Venture Debt

SWK Holdings highlights that a Venture debt encompasses a broad array of loans. Lines of credit, term debt, equipment finance, and royalty monetization are the main categories of venture debts.

Line Of Credit: Equipment or accounts receivable are examples of short-term assets that a business may invest in using a line of credit. The cash is adaptable enough to support the ongoing overhead and payroll costs, which is crucial throughout the early stages of business expansion.

Term Debt: Term debt is a loan with an extended repayment period that often has fixed interest rates. Venture debt is entirely predictable for borrowers and lenders, whether used as a senior or second-lien term loan.

Equipment Financing: the loan is mainly used for reserving expensive capital goods. The estimated life of the equipment is typically aligned with the repayment period. However, asset-free companies only benefit a little from equipment financing.

Royalty monetization is set up following the anticipated revenue stream of the borrower. The loan payments vary with an initial loan multiple as the borrower’s revenue performance varies.

In conclusion, obtaining venture debts is simpler today as long as companies can prove their creditworthiness. The businesses must ensure that they have solid business plans allowing for timely loan repayment. Entrepreneurs can accelerate performance and growth with the use of these funds.

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