Venture debt: Why it’s taking the startup space by storm

Venture debt: Why it’s taking the startup space by storm

Whether it is a company that is just starting, and needs money quickly to grow and gain metrics to gain investors, or a later stage company that needs money but does not want to have to dilute any further, venture debt is rapidly gaining popularity in the startup sphere. As per Pitchbook, the global venture debt funding hit an all-time high of $58 billion in 2021, a five-fold jump in the past eight years. However, it still remains less than 1/10th of venture equity, leaving space for the sector to grow.

India’s venture debt market is approximately just 12-years-old. Venture debt funds in India have grown in popularity, with investors seeking to reduce their risk by investing in startups via debt rather than equity. According to Venture Intelligence, venture debt funds in India raised $85 million in FY 2020-21, a steep rise from $62 million raises in FY 2019-20. More and more startups are choosing the venture debt financing path. There are tech enabled marketplaces emerging to democratize access to venture debt for both startups and investors just as we have seen in the venture equity space.

A startup’s goal is always to disrupt the sector they belong to. With traditional venture debt, a lack of strong financial standing and substantial assets can often make them weak candidates for a loan. Early stage startups are never able to receive venture debt because they do not have enough of a track record to satisfy a potential lender that their loan will be returned. However, we are now seeing that venture debt players are able to underwrite early stage startups for venture debt, because seed rounds today are the same size as Series A used to be a decade ago. And, as venture debt was available to Series A companies then, promising seed stage companies can certainly be underwritten successfully.

Normally, early stage startups find themselves in a Catch-22 where they need capital to grow, but can only get capital from investors or debt lenders once they have grown. Select venture debt firms today allow these startups to circumvent this problem by giving this capital when they need it, in multiple different currencies. This makes sense for founders, who when gearing up for raising a round, enjoy low risk on taking a bridge loan that they will be able to pay back easily after receiving funding.

Pros and Cons of Venture Debt

Perhaps the most important pro of venture debt is that it is significantly less expensive than equity. Instead of giving away pieces of the company in return for cash, venture debt ensures that the startup gets capital without diluting. This is a major advantage for co-founders, as it allows them to retain control of the company and gain capital without having to cede major rights to investors who may not fully be aligned with the startup’s goals. Venture debt allows companies access to money when they need it, without having to raise a round of funding with investors.

In an ecosystem that does not depend on credit bureau scores and other traditional loan-related technicalities, startups can even choose to take more venture debt from the same lender after establishing a relationship in a repeatable loan. Once this relationship with a lender is established, it becomes easy to get another loan, and they may be willing to be more flexible on repayment terms and provide investor introductions. In this way, a lender becomes a startup’s partner. Because of this, it is essential to find a reliable venture debt lender that is transparent with a good track record. Bad lenders that take advantage of a company’s inexperience give venture debt an imperfect reputation. While venture debt funding can be a viable alternative to equity venture financing, a startup must be well informed to utilize it correctly, and use lenders who vouch to remain founder-friendly with the terms to back it up.

Running out of money is a sure way for a startup to die a quick death, but venture debt can save a startup from this. Incorporating it into a growth strategy is a good way to smartly leverage the loan, and being able to explain the use of it clearly to a specific company will help investor meetings. Some investors can become a little skeptical upon seeing venture debt on a company’s books, due to the reputation bad lenders have left behind, and they don’t want a large portion of their money going towards paying off a loan. This can be navigated by not taking more debt than a startup can handle, and describing its use properly.

Moving forward

Venture debt is picking up steam in the startup world, and not without reason. Its non-dilutive nature and timely convenience makes it an option worth considering for a startup. It has the ability to lengthen a startup’s runway, and provides the lifeblood of startups to continue developing and growing: cash. While it has its cons, the pros are compelling enough that every startup should seriously consider taking it and incorporating it into their growth strategy.


Disclaimer Views expressed above are the author’s own.


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