Nowadays, a lot of companies need funding in order to develop and grow further. When your startup or small business doesn’t have access to bank loans and other means of capital funding you tend to look for alternative sources.
One such source is venture capital. Investors recognize startups and SMB with high-growth and high-profit potential so they decide to invest in their development. In return, investors get shares in the company’s equity and become shareholders once the company is ready to enter the stock market.
An alternative or addition to venture capital is venture debt. Venture debt is a type of loan provided by banks or alternative lenders such as ArK Kapital instead of giving away more equity of your company. Let’s have a closer look at venture debt, what it really is and how it works.
What is venture debt?
As mentioned before, venture debt is a type of loan provided to venture-backed startups and SMBs by specialized banks or alternative lenders. Unlike traditional loans, venture debt is an addition to venture capital.
Companies have to specify an objective for which they apply for a loan for using venture capital as the source of validation for the loan. Since such companies don’t have significant cash flow to obtain conventional loans, venture debt is necessary to help those companies reach a milestone or an objective that will raise their equity.
How does venture debt work?
Venture debt doesn’t involve collateral like conventional loans do. After all, startups and SMBs with high growth potential don’t have a lot of assets that could be used as collateral, to begin with. Instead venture debt focuses on company’s equity.
Venture debt loans usually involve mid-term payout conditions that are about three to four years long. In the beginning, these loans focus on interest rates but as any other type of loan, they have to be repaid one day.
The principal amount of debt is calculated based on the amount raised in the company’s last round of equity financing. This usually involves around 30% of the total funds raised.
The lenders are financed by warrants on common equity due to the high risk of the loan. After all, the lenders are providing a loan on the basis that the company will be able to to achieve the next financing milestone with enough liquidity and momentum.
Closing Words
Venture debt isn’t available to every venture-backed company. Like VCs, venture debt lenders tend to analyze company performance and objectives to determine that company’s ability to raise equity. If the company’s performance looks promising, they will have an opportunity to apply for a venture debt loan.