At The Startup CFO we are passionate about transmitting good startup practices to help budding entrepreneurs on their journey to tangible success. In this post, we are going to look at the differences between venture debt and venture capital when it comes to seeking funding, and why it is essential for entrepreneurs to understand these key concepts at the vital early stages of their startup. Let’s get started!
What is Venture Debt?
Venture Debt has become an increasingly popular option for entrepreneurs seeking additional sources of cash that do not necessarily rely on funding rounds and can be obtained from banks.
While venture capital is the dominant mode of fundraising for many startups, venture debt is seen as a way of accessing funds without giving away excessive amounts of equity, as is the case with classic venture capital funding.
Venture debt is a loan provided by a specialty lending firm or a bank that must be repaid over a shorter period. Such agreements will often come with a warrant – a legal document that allows the lender to purchase an equity stake in the company at a determined future date.
Such warrants often reinforce a rigorous alignment of interests, as both the lender and the borrower are focused on the long-term success of the business, much like the partnership element of venture capital, and this means that venture debt agreements will still involve in-depth reporting, monitoring and follow-up of your startup’s metrics and results.
Venture debt is complex and features a variety of structures and some clear advantages
Venture debt is short to medium-term in nature, highlighting the first stark difference when compared to venture capital. However, it is important for entrepreneurs to bear in mind that this will imply paying back a much larger sum of money quickly, whereas venture capital involves giving away shares of your company and suffering less short-term financial impact.
It is also important to know that venture debt depends very much on the institution in question and encompasses a range of terms, conditions and clauses which would need to be expertly analysed with a corporate or startup lawyer before signing on the dotted line. Context is everything and the size of your business is often what matters the most, meaning that venture debt can be less impacting and more beneficial as an extra support to larger startups that already have larger amounts of money and experience that allows them to pay back a loan faster.
Venture debt is complex and features a variety of structures and some clear advantages.
Venture debt works out at a lower cost, reducing existing shareholders dilution in their equity interests and giving CEOs a larger share in their own company. However, as it is structured as a loan or debt obligation of the company and must be repaid, the company takes on an additional risk. An additional advantage that startup CEOs often point out is the fact that venture debt is seen as a “hands off” approach, and while banks need to know who they are lending too, they aren’t nearly as involved in reports and monitoring of figures as venture capitalists.
Harder to access than Venture Capital
Providers of venture debt loans are few and far between when compared with venture capital, and banks are much less inclined to lend to young, early-stage startups with no proven track record. If we look at the UK as an example, key providers of venture debt include Silicon Valley Bank, Columbia Lake Partners, Finstock Capital, Shawbrook Bank, Kreos Capital, Boost & Co and Barclays, with Barclays standing out as perhaps the most recognisable high street banking name. Meanwhile, Spain offers relatively few providers of this type of support, with Sabadell standing out as a leading option for entrepreneurs.
Venture capital is frequently the preferred option
Venture capital tends to be much more accessible for early-stage startups and this tends to revolve around risk. As we mentioned above, banks aren’t as prepared to take such big risks with newer companies, while VC firms hungry for high returns often will take a risk if it means they get a larger stake in your business.
For this reason, if you decide to seek funding from a venture capital firm, it’s essential you ask for a reasonable amount of capital and strike a realistic balance depending on the state of your business and what you forecast for the short, medium, and long term.
Crucial to assess what is best for your company
As we’ve mentioned in this post, venture debt and venture capital are different approaches to funding that offer distinct options to startups looking for capital and ways of enhancing their growth and scaling up. While young startups might benefit more from approaching venture capitalists, other businesses benefit from the extra leverage offered by venture debt. This means it is essential for entrepreneurs to carefully plan and consider the options which will benefit them the most in the long run.
The importance of expert advice and reporting
In order to reach sound conclusions about the best type of funding for your startup, expert financial planning, forecasting, reporting, and management is essential. At The Startup CFO, we offer integrated external CFO services that provide entrepreneurs with thorough guidance and hands-on support in how to devise the best reports for approaching potential investors and the daily running of your startup’s finances.