Venture debt or venture lending (related: "venture leasing") is a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund

working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...

capital expenses Capital expenditure or capital expense (capex or CAPEX) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure ...

, such as purchasing equipment. Venture debt can complement

venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which hav ...

and provide value to fast growing companies and their investors. Unlike traditional bank lending, venture debt is available to

startup A startup or start-up is a company or project undertaken by an entrepreneur to seek, develop, and validate a scalable business model. While entrepreneurship refers to all new businesses, including self-employment and businesses that never intend ...

s and growth companies that do not have positive cash flows or significant assets to give as collateral. Venture debt providers combine their loans with warrants, or rights to purchase equity, to compensate for the higher risk of default, although this is not always the case. Venture debt can be a source of capital for entrepreneurial companies. As a complement to equity financing, venture debt provides growth capital to extend the cash runway of a

startup company A startup or start-up is a company or project undertaken by an entrepreneur to seek, develop, and validate a scalable business model. While entrepreneurship refers to all new businesses, including self-employment and businesses that never intend t ...

to achieve the next milestone while minimizing equity dilution for both employees and investors.

Types of venture debt

Venture debt is typically structured as one of three types: *

Growth capital Growth capital (also called expansion capital and growth equity) is a type of private equity investment, usually a minority investment, in relatively mature companies that are looking for capital to expand or restructure operations, enter new mark ...

: Typically term loans, used to extend runway between equity rounds, for M&A activity, milestone financing or working capital. * Accounts receivable financing: borrowings against the accounts receivable item on the balance sheet. * Equipment financing: loans for the purchase of equipment such as network infrastructure. Venture lenders frequently piggyback on the

due diligence Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to take before entering into an agreement or contract with another party or an act with a certain standard of care. It can be a l ...

done by the venture capital firm. For loans provided to loss-making companies, lenders often rely on the next round of venture capital financing or venture debt refinancing for their repayments. Venture debt providers are typically classified into two categories: 1. Commercial banks with venture-lending arms These banks typically accept deposits from the startup companies, and offer venture debt to complement their overall service offerings. Venture debt is usually not bread and butter for these providers. Debt lines from the banks start as low as $100,000 and for appropriately backed and/or companies with scale, can reach into the tens of millions in terms of facility sizes. Some players in this category are: * City National Bank *

Comerica Comerica Incorporated is a financial services company headquartered in Dallas, Texas, and strategically aligned by three business segments: The Commercial Bank, The Retail Bank and Wealth Management. Comerica focuses on relationships, and helpin ...

(NYSE:CMA) *

East West Bank East West Bank (), the primary subsidiary of East West Bancorp, Inc., is the largest publicly traded bank headquartered in Southern California, United States. It was founded in 1973 in Los Angeles to serve the Chinese American community in Sou ...

(NASDAQ:EWBC) * HomeStreet Bank (NASDAQ:HMST) *

Silicon Valley Bank Silicon Valley Bank is an American commercial bank. SVB is on the list of largest banks in the United States, and is the biggest bank in Silicon Valley based on local deposits. It is a subsidiary of SVB Financial Group. History Silicon Valley B ...

(NASDAQ:SIVB) *

PacWest Bancorp PacWest Bancorp is a bank holding company based in Beverly Hills, California, with one wholly owned banking subsidiary, Pacific Western Bank. It has 69 branches in California, primarily in the southern and central parts of the state, one in Denv ...

(NASDAQ: PACW) with their Venture Banking Group, formerly known as Square 1 Bank. *

Wells Fargo Wells Fargo & Company is an American multinational financial services company with corporate headquarters in San Francisco, California; operational headquarters in Manhattan; and managerial offices throughout the United States and inter ...

(NYSE:WFC) 2. Specialty finance firms ("venture debt funds") Many independent non-banking lenders have emerged over the years in USA, Europe and Asia. These funds are focused solely on providing venture debt and also have the ability to provide higher dollar size and more flexible loan terms. Some of these are: North America *TriplePoint Capital (NASDAQ: TPVG) *Hercules Capital (NYSE: HTGC) *Horizon Technology Finance Corp (NASDAQ: HRZN) Europe *Kreos Capital *European Investment Bank Southeast Asia *Innoven Capital

Industry Dynamics

As a rule of thumb, the size of venture debt investment in a company is roughly 1/3 to 1/2 of venture capital (equity). The VC industry invested around $27B in the last 12 months. This would imply around $9B potential debt market. However, not all VC-backed companies receive venture debt, and a study has recently estimated that lenders provide one venture debt dollar for every seven venture capital dollar invested. This implies around $3.9B debt market. There are several philosophies behind the various players. As a rule, they all prefer better branded VCs backing any potential portfolio company - some are more militant about this than others. They universally will provide capital to companies still in a money loss mode, with variances around comfort on timelines to breakeven, next round of capital, recently raised equity, etc. Since most startups tap into venture debt to augment equity, the size of the venture debt industry follows the movement of the VC industry.

Financing terms

Venture debt lenders expect returns of 12–25% on their capital which is achieved through a combination of loan interest and capital appreciation of warrants . The warrants help compensate for the higher rate of perceived level of risk on these loans taken by the lender and therefore, these warrants provide incremental returns from equity ownership in the target companies that are successful and achieve a trade sale or

IPO An initial public offering (IPO) or stock launch is a public offering in which shares of a company are sold to institutional investors and usually also to retail (individual) investors. An IPO is typically underwritten by one or more investment ...

. Equipment financing can be provided to fund 100% of the cost of the capital expenditure. Receivables financing is typically capped at 80–85% of the accounts receivable balance. Loan terms vary widely, but differ from traditional bank loans in a number of ways: * Repayment: ranging from 12 months to 48 months. Can be interest-only for a period, followed by interest plus principal, or a balloon payment (with rolled-up interest) at the end of the term. * Interest rate: varies based on the

yield curve In finance, the yield curve is a graph which depicts how the Yield to maturity, yields on debt instruments - such as bonds - vary as a function of their years remaining to Maturity (finance), maturity. Typically, the graph's horizontal or ...

prevalent in the market where the debt is being offered. In the US, and Europe, interest for equipment financing as low as

prime rate A prime rate or prime lending rate is an interest rate used by banks, usually the interest rate at which banks lend to customers with good credit. Some variable interest rates may be expressed as a percentage above or below prime rate. Use in dif ...

(US) or

LIBOR The London Inter-Bank Offered Rate is an interest-rate average calculated from estimates submitted by the leading banks in London. Each bank estimates what it would be charged were it to borrow from other banks. The resulting average rate is u ...

(UK) or

EURIBOR The Euro Interbank Offered Rate (Euribor) is a daily reference rate, published by the European Money Markets Institute, based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro who ...

(Europe) plus 1% or 2%. For accounts receivable and growth capital financing, prime plus 3%. In India, where interest rates are higher, financing may be offered between 14% and 20%. * Collateral: venture debt providers usually require a first

lien A lien ( or ) is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation. The owner of the property, who grants the lien, is referred to as the ''lienee'' and the pers ...

on assets of the borrower like IP or the company itself, except for equipment loans where the capital assets acquired may be used as collateral. * Warrant coverage: the lender will request warrants over equity in the range of 5% to 20% of the value of the loan. A percentage of the loan's face value can be converted into equity at the per-share price of the last (or concurrent) venture financing round. The warrants are usually exercised when the company is acquired or goes public, yielding an 'equity kicker' return to the lender. * Rights to invest: On occasion, the lender may also seek to obtain some rights to invest in the borrower's subsequent equity round on the same terms, conditions and pricing offered to its investors in those rounds. * Covenants: borrowers face fewer operational restrictions or covenants with venture debt. Accounts receivable loans will typically include some minimum profitability or cash flow covenants.

Use-cases of venture debt

There are three primary scenarios where venture debt is considered by companies: * Extend cash runway to next valuation: Venture debt can be used to extend the cash runway of a startup company to the next valuation driver. A company could raise a smaller equity round and then leverage venture debt to ensure the next equity round is raised at a higher valuation. Management and employees would benefit from less dilution due to smaller equity raises while existing investors would also benefit from less equity dilution and less cash required to maintain their ownership position. * Extend cash runway to profitability: Venture debt can extend the runway of a company to be "cash flow positive". The company can leverage venture debt to eliminate a last round of equity financing. This use of debt reduces equity dilution for both employees and current investors, and propels the company forward during a critical period of growth. * Avoid a down round: Venture debt can serve as a cushion for when a company does not perform to plan and does not have enough cash to last between equity rounds. In the case where a company's performance is not up to its plan, it will likely result in raising equity at a down round. Venture debt could have helped bridge the gap until the company is back on track.The Value of Venture Debt
29 August 2016

Types of venture debt

Industry Dynamics

Financing terms

Use-cases of venture debt

See also

References

External links