Venture Debt is having a moment. European and UK-based tech companies raised €30.5bn from debt last year, almost double the amount raised in 2021.
The financing option has risen in popularity partly because attitudes towards it have evolved. Looking to raise Venture Debt is now widely regarded by shareholders as a sign of financial prudence and is anything but a ‘red flag’. It is seen for what it is: a facility that can operate as a helpful, non-dilutive supplement to equity in fuelling growth.
But what actually is 'Venture Debt'? And what does raising it involve in 2023?
Today there is greater Venture Debt optionality in Europe, as more and more funds are making a home on the continent as demand increases. This has created healthy competition, but more choices can be daunting for founders.
So, what do founders need to know? B2B technology investor Daniela Raffel Torrebiarte at Dawn Capital asked three industry experts for their insights to pull together a handy guide to help founders navigate Venture Debt.
The experts are:
- James Downing, the London-based European Managing Director for US venture lender, Hercules Capital. The listed fund writes cheques from $15m to $150m and deployed around $200m into European companies last year.
- Juliet Rogan, Managing Director at Silicon Valley Bank UK. SVB UK is one of the largest venture debt providers in Europe. SVB UK is a subsidiary of HSBC.
- Eliott Saba, Partner at Bootstrap Europe, which has offices in Zurich and London. The Bootstrap team has underwritten over 260 deals to date, is currently investing €1m to €15m tickets to tech and life sciences startups from its third venture debt fund.
Read on to discover their top tips on the vital questions to ask when considering Venture Debt and the ways to ensure that you, as a founder, make the right decision for your company.
What is Venture Debt?
Venture Debt has started to become a catch-all term to describe any type of debt financing available to early and growth-stage companies.
While traditional venture funding sees investors exchange capital for an equity stake in a company, Venture Debt sees lenders offer loans in exchange for specific benefits, plus interest payments.
It is a type of financing typically available to companies that have already completed a funding round and that have solid plans to raise further equity in the future. Raising Venture Debt is not like taking out a conventional loan, and usually comes at a slightly higher price.
Eliott explains: "At its core, Venture Debt is the most flexible type of debt financing. It comes without covenants and is built specifically for loss-making businesses that are inherently less predictable, where the company can use the funds in the same way as equity."
When is the right time for a startup to raise/consider Venture Debt?
Venture Debt isn’t for everyone. Companies best positioned to raise it tend to have at least 12 months of runway and plans for another equity round in the near term.
James says there is a real art in timing a Venture Debt raise.
He advises: “Certainly do not leave it until your cash is very low. This is not attractive to lenders, and you will not be in a good negotiating position.”
Juliet suggests raising alongside or just after completing an equity raise.
She says: "You will have the work done from Due Diligence on the equity, so it is a more streamlined approach. In the current environment, liquidity and the ability to control cash burn are both important considerations for a venture debt lender.”
If you’re unsure whether to raise Venture Debt, Eliott says it’s worth asking two important questions:
Does raising Venture Debt enable me to raise the next equity round a few quarters later, at a higher valuation?
Are we planning to double down on sales with a larger ROI than the debt cost?
If the answer to either of the questions above is ‘yes’, then it may be a good pathway.
If you intend on raising Venture Debt but have less than 12 months of runway, Eliott has another top tip: To try considering an internal equity raise, and then leveraging that fresh equity to raise venture debt alongside it.
How can founders work out which Venture Debt provider to choose as a partner?
The different providers, and what they offer:
There are two broad categories of Venture Debt provider to choose from: Specialised investment funds, and banks with a venture debt arm.
Both offer various products, terms, and relationships. The right option will depend on each individual company’s circumstances.
James says that banks generally offer founders a cheaper overall package. They are also more likely to offer a wider range of products and more structured debt products addressing specific working capital needs.
However, James also points out that banks tend to have lower quantums than funds, and says that funds will typically provide more flexibility and larger ticket sizes. Eliott adds that speed of execution is also a key differentiator, as funds can “make decisions for new investments and portfolio companies extremely quickly”.
Some key things to do when choosing a lender/ deciding on a type of facility:
In-Depth Due Diligence
Taking on Venture Debt means forming an important new partnership for your company, and Eliott shared some insights into doing Due Diligence on lenders.
He says: “You should take as much care picking your lender as you do your investors.
“If things go well then you need someone who will continue supporting you over time. And, if things don’t go well, you need to make sure you're picking someone you trust will be supportive and flexible if you can’t meet your payments.”
- Meet with potential lenders in person where possible
- Reference the fund or bank with their portfolio
- Get your existing investors “on board with the decision”. And no matter how good the deal looks on paper, make sure that any decision is made based on real mutual respect "Remember that whoever you pick will be senior secured over all the assets of your business – so while terms are important, trust is even more so”.
Three key questions for founders to consider:
What do I need the debt for?
Eliott says: “If you are looking for a large upfront quantum to finance M&A, or simply runway extension, then you should approach a fund for its speed and size.
“If you have a growing working capital need, even if very specialised - such as client fund movements in money remittance - then trying to get a revolving facility from a bank can be a better idea. You can draw on that and repay at will.”
How long do I need it for?
James says it’s important to consider the structure of any facility.
Founders should ask: Does the facility have amortisation (repayment) within the term, or will it be repayable on maturity (known as a bullet payment)?
“Loans with bullets give maximum value of the debt, but create a possible refinance risk at the term end, so it is important to understand what works best for your business,” James explains. “If you do not plan to pay off the debt facility through profitability, then you will most likely need to refinance.”
It’s also important to look at a lender's ability to match your ambitions.
James says: "Is your facility at the upper end of your chosen lender’s range? If so, then they may not be able to scale with you, if you hit your growth targets and need to upsize the facility before the end of the term.”
Juliet points out that this is a key factor to consider partly because “it is much easier - and more cost-effective - to get extensions to facilities from an existing provider”.
Will the jurisdiction in which I’m based have an impact?
Also, remember that many Venture Debt lenders operate in specific jurisdictions, so don’t waste time approaching lenders who will never become partners.
A handy checklist: “Warning signs” to look out for on a Venture Debt term sheet…
- Unusual, off-market or unexpected terms
If you are already VC-backed, they can help you compare terms. If you are not, aim to get at least two term sheets to compare and contrast
- Capital available at lender discretion, rather than committed
Juliet says that it’s vital to look out for any clauses that will impact your ability to draw down on the facility when you need it. Make sure to check if the quantum is all available from day one.
- Milestones / covenants
James explains: “Things like minimum cash covenants can actually stop you from accessing the debt when you actually need it.”
- Additional fees
Juliet says: “If using the debt as an insurance policy, compare the cost of the facility when undrawn vs drawn, as incremental fees and warrants can come into effect when you draw down on the facility.” Also, look out for ‘end of life’ fees or the costs associated with refinancing or repaying the debt.”
- A surprisingly low interest rate
Make sure to check the details, Eliott warns. “Sometimes a low interest rate can seem tempting, but a combination of commitment fees and maturity fees can mean the lowest interest rate term sheet is actually the most expensive.”
And finally, what should founders who have raised Venture Debt do when things haven’t gone to plan?
Sometimes companies take on Venture Debt and later find themselves unable to make repayments. Our experts have seen what happens in these scenarios, and had some helpful tips to share with anyone facing this issue.
“Cash crunches are common: Talk to your lender as soon as possible”
Juliet says that it’s key in this situation to “make sure that you are engaged with your lender and have an ongoing dialogue”, and to get processes started ASAP. “When things are not going to plan it is much easier to restructure a facility when there is some time,” he explains.
Eliott adds that it’s also helpful to remember that you’re not alone – restructuring facilities is extremely common in Venture Debt. “Over 40% of our portfolio companies have had their loans restructured, from very basic principal payment deferrals to full-on remodelling of the loan.”
And get your shareholders on-side
Our experts explained that shareholders offering to contribute via a convertible. Having shareholders on-side can make all the difference when it comes to debt restructuring. They can be a huge asset, as they can work with both founders and debt providers to help broker an agreement that works for all parties.