Note: Capital Advisors Group is a Boston‐based institutional investment advisor that has been helping venture‐backed companies invest their cash assets for more than 20 years. Debt Advisors Group is the venture debt consulting arm of Capital Advisors Group, which helps venture‐backed companies determine their optimum capital structure, identify appropriate lenders, source term sheets and negotiate deals.
What Is Venture Debt?
Definition: Venture debt or venture lending is a type of debt financing provided to venture‐backed companies by specialized banks or non‐bank lenders to fund working capital or capital expenses, such as purchasing equipment. Unlike traditional bank lending, venture debt is available to startups and growth companies that do not have a track record of positive cash flows or significant assets to use as collateral.
This definition of venture debt appears fairly straightforward in its own right, yet the prospect of this type of financing for a venture‐backed company can become one of the most divisive topics at the board level. Some board members may embrace the idea of exploring this type of financing as an option to help extend the company’s cash life while, ultimately, posing less dilution to existing investors than would additional outside equity investors. Some, on the other hand, cast a distrustful eye toward the lending community and may feel some venture debt terms place onerous restrictions on the company.
The truth is both impressions may be correct. It is important to understand, first and foremost, that not all lenders are alike. Some lenders truly may be interested in supporting the companies to which they lend and seek to build relationships and long‐term partnerships in the process. Conversely, some less‐established lenders may view their function as a simple transaction and may seem to be interested in little more than getting their principal and interest out of the deal and moving on to the next deal. Seeking out the best lenders and weeding out the rest is a crucial first step in any venture debt deal.
When It Makes Sense
Venture debt typically makes the most sense when a company can use it strategically to reach an important milestone or inflection point (i.e. clinical trials or a crucial R&D stage) that will help it move forward. IMPORTANT: Debt deals should not be pursued with the sole intention of putting more money on the balance sheet. It is imperative that CFOs review their projections, burn rates and expected milestones and determine exactly how a particular debt deal can help extend the company’s cash runway to reach those milestones or the next expected equity round. Typically, venture lenders prefer to see the following conditions met before partnering with a company on a deal:
- At least 12 months of cash
- Strong VC investors
- Strong management team and product