Venture debt accounted for 30 per cent of all venture capital raised in European tech start-ups in 2022, according to Dealroom – about double the percentage from the previous six years.
But what exactly is venture debt? How do you get it and with the collapse and subsequent buyout of pioneer venture debt provider, Silicon Valley Bank (SVB), is it a good option for growing businesses right now?
What is venture debt?
Venture debt is the loaning of capital to early stage, high-growth businesses which are backed by venture capital. It provides a start-up with liquidity between equity funding rounds and comes on top of venture capital, not instead of it.
Venture debt can be offered to start-ups and scale-ups that don’t have significant assets and doesn’t require them to give up a stake – minimising the risk of equity dilution.
The European Investment Bank likens the finance option to a student loan for a young business – where there are no assets to the company’s name but expect future earnings and returns.
“Venture debt is essentially the first piece of debt a young, typically tech, company which has already had some – perhaps Series A or Series B – equity is going to take on,” Brett Israel of law firm Marriott Harrison tells Growth Business.
“It offers one core benefit for a company like that: by the time you’ve had two or three rounds of equity funding, you’ll potentially have quite a complicated cap structure, which means trying to do anything with shareholders becomes more complicated because you need lots of consent – it becomes a slow and perhaps cumbersome process.
“Venture debt rides over that because there’s no need to amend the shareholder position. It means there is no dilution.”
Why and when do you need venture debt?
Venture debt serves two main purposes: to extend the runway of the equity round and act as a start-up’s insurance policy in the event costs are higher than expected.
“You can use venture debt for a whole range of purposes,” Israel says. “Typically, it is used for something more one-off, like a strategic move to a new market or an acquisition trail.”
Founders can approach debt providers directly in between fundraising rounds, but sometimes venture capital firms will approach providers to help support a start-up.
The capital can then be used to finance R&D or purchasing equipment – the main benefactors tend to be companies in life sciences, SaaS and deep tech.
Venture debt vs venture capital
Venture capital provides capital in exchange for a slice of the business and usually a place on the board. VC investors are typically veterans in the industry who can link start-ups to contacts and provide advice.
Venture debt is an addition to venture capital and has the sole purpose of providing an early-stage business with liquidity in between funding rounds. Providers don’t require a member on the board, but in some cases can offer advice.
Venture debt vs traditional loans
Venture debt loans serve a different purpose to traditional bank loans. Debt serves high-growth, mostly pre-revenue start-ups backed by venture capital. So, while traditional banks require positive cashflow as proof you can pay back the loan, venture debt providers take into consideration venture capital raised and future revenue.
As this is more risky than traditional loans for the lender, debt providers tend to follow venture capital investors they trust to give them the confidence in providing the loan. The interest rate is also higher – usually ranging between eight and 12 per cent – and pay-back terms tend to be shorter, usually between one and two years.
They may also take an equity warrant – a bit like a stock option. They will want an equity kicker, which is to say if your business is doing well, they’ll have a chunk of the shares at the end of the loan period.
“Lenders are trusting what the management tells them about the trajectory of a business,” Israel says. “It’s about the business plans, projections and prospects of the young business.
“That’s risky. This is the first time these businesses take on debt. You’re pushing the lender to act as a quasi-investor because they’re taking an earlier stage risk than most banks would ever touch.”
What are the requirements?
Requirements from providers vary, but generally, they require companies to have completed one or two funding rounds from private investors before backing them. Other providers will require a business to have enough runway – usually around six months’ worth.
Lenders will also typically do the same background checks as a VC firm when looking to back a business, such as market fit, challenges and scalability.
“There are guidelines which are quite industry standard,” Israel confirms. “For example, has the business already had a few million by way of equity already invested in it over several rounds? Is the business on an improved revenue basis? You want the revenue to be increasing over the period of the loan which typically is around two to four years.”
How much can you borrow?
The size of debt you can take on varies by provider, but some say an early-stage business can hope to achieve a loan of 20 per cent and 35 per cent of their most recent equity round. This tends to be anywhere between £1m and £10m.
Venture debt is very rarely a long-term solution. Most repayments are made anywhere from 18 months to three years and most providers expect to be repaid from the proceeds from the next funding round.
Should I be worried about the SVB buyout?
The buyout of the pioneer of venture debt, Silicon Valley Bank (SVB) caused concern in the industry, but should it affect your thoughts about using venture debt?
“If your exposure to SVB was because you had money deposited with them, that’s different than if you’re a venture debt borrower,” Israel assures. “If the latter, the problem is not so much yours, but the bank.
“Does everything that happened with SVB change venture debt in this country? The answer is no. It certainly caused a massive rupture in the market for a few days, but in fact it didn’t change anything.
“If anything, the venture debt market will be stronger because you’ll have more players coming to the fore than SVB. In fact, it’s probably indirectly a stimulus to some of the other lenders.”
Advantages and disadvantages of venture debt
- Can provide a start-up with significant runway
- Reduces the need to fundraise more or sell equity
- Doesn’t require a new member on the board
- Can unlock further equity down the line
- Can be difficult to pay back the high interest loan if the company fails
- Difficult to obtain for most start-ups – you’ll need VC backing in the first place
Venture debt providers UK
- Choice of 2-4-year term loan or 2-5-year bullet loan
- For businesses looking for $1-5m in first tranche in tech and SaaS
- Annual revenue of more than $4m or ARR greater than $2.5m
- Experienced founder with “substantial ownership positions”
- Quantum: £1m – £10m limit
- Term: 3-year term
- Debt to equity: less than 33 per cent
- Presence of existing investor (VC, PE or family office) in company shareholding
- Enterprise value +£10m (based on previous fund raising)
- Growth of 20 per cent and over forecasted for next 12 months
- Minimum existing sales revenue of more than £2m
- Existing contracts with diversified client base
- Working towards break-even