As any start-up founder knows, launching a new business can be an exhausting and all-consuming experience. When not dealing with day-to-day operations or handling accounts, there are investors to deal with and venture funding to be raised, often from multiple backers with competing agendas.
PARTNER FEATURE
As any start-up founder knows, launching a new business can be an exhausting and all-consuming experience. When not dealing with day-to-day operations or handling accounts, there are investors to deal with and venture funding to be raised, often from multiple backers with competing agendas.
The herculean efforts made by many entrepreneurs to juggle all this helps to explain the growing popularity of venture debt as a source of funding.
It already makes up a large proportion of US venture capital funding and is now also growing in popularity in Europe, says Alex Di Santo (pictured) of Crestbridge, a Jersey-based firm which specialises in services to venture debt funds.
Crestbridge, which employs over 500 people in eight offices around the world, offers a range of financial services for clients in the private equity, real estate and family office sectors.
Venture debt
Venture debt is a form of short- to medium-term debt financing generally provided to venture-backed companies by non-bank lenders or other specialist banks.
Used to fund growth or extend the runway, venture debt has, over the past 10 years, emerged as a growing source of funding for start-ups.
In a world of low interest rates, it can be a relatively cheap way to fuel growth and is often used to supplement equity finance raised from other sources.
Typically, start-ups will access venture debt after their first or second big rounds of equity funding.
Between 2018 and 2020, over USD80 billion in loans and other debt products were created for VC-backed companies in the US, up from USD47 billion in the previous three years, according to PitchBook figures.
Now a similar trend is underway in Europe as founders recognise the benefits and big players in the market, like Silicon Valley Bank, seek to broaden their offering to new geographies.
Non-dilutive funding helps founders
Perhaps the biggest advantage over regular equity funding is that venture debt is non-dilutive, allowing founders to retain control over their business while also raising essential funds.
“When taking venture debt over equity there’s no dilution so there can be more upside for the founders,” Di Santo says, adding that venture debt managers don’t require governance rights through board seats or specific approval rights around eg key hires, exit etc. “So venture debt avoids the relinquishing of control by founders.”
Research in the US indicates that founders using venture debt can, when reaching Series D, retain around an extra 10 per cent of ownership when they combine venture debt with equity, compared with using just equity financing.
Pandemic boost
That’s one reason why the industry experienced a surge in interest during the Covid-19 pandemic, when many start-up founders found themselves in urgent need of funding to keep their businesses afloat but were often understandably reluctant to relinquish control.
“When Covid emerged, we saw lots of activity in the space because early-stage companies were after capital and they didn’t necessarily want to go down the equity route,” Di Santo says.
Another benefit is the speed with which debt finance can be arranged and accessed.
Typically, it takes less time to access capital than with equity investment, where potential backers – whether private equity, angel investors or venture capital firms – usually demand more time to meet with founders, discuss the business model and conduct detailed due diligence.
“Venture Debt can be very quick to access so the whole process can be much quicker than an equity raise,” says Di Santo, adding that this can help founders execute rapid bolt-on acquisitions if an opportunity arises.
Alternatively, the debt funding can be used to hit another key milestone for the business in order to bolster a corporate valuation for a subsequent equity fundraising.
The growing popularity of venture debt has been fuelled in part by its widespread acceptance in Silicon Valley as an effective way to power the growth of early-stage companies.
“In the US, venture debt is tried and tested and well known and it’s a well-established asset class,” Di Santo says.
“Silicon Valley has been ahead of the curve in the Venture space and the same applies to Venture Debt. In Europe, it’s less popular. There are very few venture debt managers but the trend we’re seeing is an increase in European managers moving into venture debt.”
Europe is lagging in booming market
He says that in Europe there are still a relatively small number of Venture Debt providers who are active in the market, although the number is growing.
With more players active in the sector, the lending market is becoming more competitive with better deals on offer for borrowers.
Start-ups increasingly can access funding on highly favourable terms, with lighter covenants, fewer demands for warrants and often lengthy interest only periods available.
Of course, debt financing does not come without risk and critics say the combination of start-ups and elevated levels of debt at such an early stage in their development can raise red flags.
“Obviously if you get into trouble and you can’t repay the loan, things can become difficult. The venture debt provider could take control of the assets,” Di Santo says.
“There can also be early repayment fees associated with Venture Debt and success is generally reliant on successful equity funding. It’s not for everyone. Debt needs to be taken at the right stage of the lifecycle of the business,” he adds.
At the very least, the company needs to be at the point where it has proven recurring revenues so it can afford to make the necessary debt repayments.
