My company closed a venture round a while back and now we are starting to look for our next round of funding. We are looking at venture debt as a way to "extend our runway". I hear of companies using venture debt all the time as a runway extender, but do we need to have pulled the debt sooner after we closed our last round, or is it more about our particular company outlook at this time?
Does my company need to have had a recent venture investment in order to "qualify" for venture debt?
Answers
While the most common time to explore venture debt is shortly after an equity round, it isn't the only time that it makes sense. Debt often comes into play in between rounds too. The use cases for considering debt in between are generally to 1) make unexpected investments (new product line, sales channel, clinical trial, acquisition), 2) add more sales resources because you have begun to figure out the sales model and want to add more fuel to the fire, or 3) to make up for unplanned delays or less than expected growth rates.
The first two are relatively easy to finance while the third may be more difficult (but not impossible) as lenders generally want to finance positive situations. If you are getting low on cash (under 6 months) it is likey too late and you should focus on raising equity. Most venture debt players don't want to be true bridge lenders.
In my experience, the venture debt lenders fall into two categories: 1) banks who are most interested in the equity sponsors of your company (i.e., will your investors step in with bridge financing if you can't close the next round before you run out of cash) and your likelihood that you will actually be able to raise the next round and; 2) other lenders who want to know (or be convinced) that this money will take the company to (or near) cash flow breakeven or to the point of qualifying for equity financing. Be aware that the venture lender will take a first position on the Company's assets (usually including IP)...
Venture debt is in the middle of a bit of a renaissance in recent years, but it's important that you understand the incentives each party plays in this unique capital structure.
Venture debt really became prevalent during the 1990s, where it was used primarily to finance the
After the bust, venture debt focused more carefully on financing capital equipment expansion. The best example of this is TriplePoint Capital lending money to YouTube and later Facebook to help those companies buy the massive server farms that powered their expansion. Call it a return to rationality.
Startup founders love to get more cash without giving up additional equity to their venture capitalists. Faced with ever-lengthening times to liquidity and larger financing syndicates, each venture firm likes not having to dilute its stake by sharing in another round. Banks like the higher rates they can get from this kind of investment and often assume that the venture capitalists won't let the startup default on its debt.
As someone who's worked at startups and advised CEOs on their financing plans, I often encourage them to take on some leverage, if they can get it at good terms. It helps keep a consolidated shareholder base and provides some level of
Still, entrepreneurs have to be mindful of the additional
There have also been several bad apples in the venture debt bushel in recent years. Most notably Boots Del Biaggio, who was convicted of fraud (http://nyti.ms/VPta) and LRG Capital's Larry Goldfarb has recently been charged with fraud (http://bit.ly/gp56sz) It always pays to double check on your investors, but especially in the venture debt arena.
The recent uptick in venture debt interest is due to the rise of Super Angels and small venture capital firms who don't want their companies to go on to raise larger rounds from other venture firms. Angels and small fund shops know that they'll get "smashed down" in any subsequent financing round with a major venture capital shop, so they send their entrepreneurs out in search of non-dilutive debt financing. "Extend the Runway" is a euphemism for "preserve our equity stake."
Angel investors are most likely to push this as a strategy onto their entrepreneurs if they believe the startup is a feature or product that is likely to be acquired instead of a stand-alone company that is likely to go public. They're terrified of getting nothing if a larger firm comes in and demands a 2x liquidity preference.
That said, the value-add of an additional venture capital firm is often over-estimated by entrepreneurs. Taking on debt may be a great way to keep more equity in everyone's pocket while the company proves the value of its product or offering.
You can get venture debt whenever you want. There's no requisite link to a recent round of financing, but to quote Eugene Caufield, "the best time to take the cookies is when they're being passed."
Alexander Haislip is the author of Essentials of Venture Capital
Filed Under:
FP&A