• Congrats! You’ve started a business. Now, you’d like to keep the doors open, and grow. In order to do this, you may need outside funding (not your own). How do you fund your new business? There is more than one way to do this. We’re going to focus on two options: venture equity, and venture debt.

  • VENTURE EQUITY or “venture capital” is a popular form of financing for start-ups. This is a form of funding that is invested in exchange for a fixed share of the company (or ‘company equity’) at an undetermined amount of value as a company grows.

  • VENTURE DEBT is less well-known. This is a form of funding that a company borrows (there is no exchange of company equity) in the form of a loan at a predetermined interest rate, allowing companies to finance themselves.

  • Below, you can find more detail on the two forms of funding – what form of funding is more appropriate for you, when, etc.

For more details, read below.

  • Typically available for companies at multiple stages, including early stage. 

  • Typically available for companies who have not previously received VC funding.

  • Provided by VCs who take an equity stake in a company, at sometimes a sizable scale.

    • Venture equity is dilutive. For example, if a company raises $5M on a pre-money valuation of $20M, the company is giving up 20% of company ownership, handing a portion of the potential total upside to the investor. 

    • Investors also tend to have more “say” in the company’s trajectory, since, via equity stake, they may take a board seat / advisory position.

Equity fluctuates in value over time – sometimes dramatically. This poses more risk and reward for an investor. If an equity stake increases in value over time, this can mean more value for an investor and a loss in potential value belonging to the company.

  • There tends to be a more rigorous due diligence process relative to the due diligence process that tends to be involved in venture debt deals, since, in the former case, companies are still ‘unproven.’ Venture equity investments require company valuation.

The amount of funding doesn’t have to be paid back directly to the investor. VCs make money by selling equity during an exit opportunity.

Typically available for companies past the early-stage – typical exceptions include companies that are generating growing revenue (with high confidence).

  • Typically available for companies who have received VC funding.

  • Provided by bodies that do not necessarily take an equity stake in the company (other than that paid in interest to the investor).

    • Venture debt is non-dilutive. For example, if a company can raise venture debt, then $5M might cost the company $6M over a few years due to interest, but if they have the cashflow to do that, it doesn't cause any dilution.

    • A venture debt investor tends to have less “say” in the company’s trajectory, since the funding is a fixed loan without an equity state or a board / advisory seat.

    • There is no equity fluctuation, since there is no equity (other than that paid in interest to the investor). This poses less risk and less reward for an investor. Potential value stays with the company.

  • There tends to be a less rigorous due diligence process relative to the due diligence process that tends to be involved in venture equity deals, since, in the former case, the company is already ‘proven.’ 

  • Startups must pay back venture debt over time. Venture debt lenders make money through interest payments, fees, and warrants, which can convert into equity at a later time.

More details about VENTURE DEBT:

Venture debt makes sense for certain businesses over others. As a company progresses from early-stage to late-stage, presumably seeing growing recurring revenue, increased profitability and predictable top-line performance, more financing options, including venture debt, become available. Sectors that can attract venture debt investors examples include:

  • SaaS: recurring revenue can be achieved quickly among SaaS companies due to the immediate availability of online markets.

  • Life sciences: these companies can receive recurring revenue from licensed IP or an approved drug or medical device.

Venture debt makes sense for businesses trying to accomplish certain goals.

  • A cushion: If the startup takes longer than anticipated to reach its next developmental stage, then venture debt could come in handy as insurance.

  • Covering under-performance: During a market downturn, venture debt can keep a company afloat so that it doesn’t suffer any significant losses during said downturn.

  • Avoid Bridge Rounds: bridge rounds can be expensive to accomplish, produce a negative image for the company and further dilute the ownership of a company. Venture debt can negate the need for a bridge round by providing funding without generating the aforementioned potential expense(s), negative image and ownership dilution.

  • Funding inventory: as a company grows, acquiring more customers, its inventory increases. In order to fund this inventory, debt is preferred, over giving away more of a company. Once a company has a track record, it can switch to more traditional forms of debt financing but until then, ordinary lenders may be unwilling to loan funds, which is where venture debt comes in.

Final note:

Funding options not mutually exclusive. It is common to utilize more than one given a goal of an optimized capital structure and minimized weighted average cost of capital.‍

Questions? Email Skye Grayson: skye@quidnetventures.com 

Author: Skye Grayson