Oscar Jazdowski, head of origination, Silicon Valley Bank
In today’s competitive business environment, growth companies need to make the most out of every penny of financing they secure. There is an additional layer of financing that venture-backed companies increasingly look to as part of their long-term growth and exit strategies – venture debt.
Venture debt is a form of debt financing (i.e. a loan) provided by banks or specialised venture debt providers. It is typically only granted to growing companies that have already raised equity from institutional venture capital firms. However, unlike traditional bank lending, venture debt is available to companies that do not have a positive cash flow (or sometimes any cash flow at all).
Let me give you an example. If a company has raised £5m after a round of equity financing (giving away a percentage of the ownership of the business – think Dragons’ Den), that company could seek venture debt from a provider without any significant further dilution to equity. While venture debt is substantially less dilutive and expensive than equity, it will include a small warrant component. A warrant is an option for the provider to purchase shares at a pre-determined price.
Why would the provider of venture debt offer this sort of financing? Well, any venture debt provider is making an assumption. If a company has already raised equity from top-tier venture capital firms that the lender trusts, the provider assumes that the company will get further rounds of financing from those or other investors. This assumption gives comfort to the provider so that it can offer a level of debt unusual for an emerging company to secure.
Typically, venture debt has a three-year “amortisation period”. This means that the debtor company would have to pay back the debt in equal instalments over 36 months. The facility may include a draw period or interest-only period for additional flexibility. The loan is secured by a fixed and floating charge over all assets, including intangibles such as intellectual property.
How much does it cost the borrowing company? Venture debt carries greater interest than a conventional bank loan. If a typical bank loan has an interest rate of 8%, venture debt will typically be priced at a premium and on average no more than 14%.
This may sound expensive and you could be wondering why a company would want to take on such financing. Aside from the acute lack of availability of normal bank lending, the reason is that venture debt can extend a growing company’s liquidity without diluting its equity. If a company has raised £5m from venture capital firms and an extra £2m in venture debt, it has £7m of liquidity. Depending on how quickly it burns cash, the extra £2m might extend its operational lifespan by a few quarters or up to one year. This could be the difference to the company hitting a major milestone to help drive its valuation, reach profitability or even achieve an IPO, before looking to raise additional financing.
Think of venture debt as extending a company’s financial runway. It typically comes with no financial covenants and no personal guarantees. It is essentially a non-callable piece of capital that is far less expensive than equity. Yes, venture debt is more expensive than a conventional loan in terms of interest rate but it provides entrepreneurs with a means of significantly increasing their company’s liquidity while not giving away any of their business.