What is Venture Debt Financing? | Venture Debt Guide – Part 1



Originally a type of asset finance called Venture Leasing, venture debt was not established in the UK until the early 2000s.  


Since then, the market has exploded. In 2020, Silicon Valley Bank estimates that the run rate for the European venture debt market is at a comfortable $1.5Bn. 


Now having evolved, venture debt is one of the growth products of choice for scaling technology businesses in the UK and Europe.  


In part one of this four-part guide, you will discover everything you need to know about flexible growth capital. 


Use the contents section below to skip to specific areas of interest.



1. Let’s define venture debt


2. Four reasons CFO’s choose venture debt


3. How you can use the funds


4. Differences between venture debt and bank debt

Part 2: What’s the difference between equity and venture debt?


Part 3: What’s the difference between venture capital and venture debt?


Part 4: How does venture debt work?


Start here – let’s define venture debt


Venture debt is a form of debt financing specifically designed to meet the needs of scaling startup and pre-profit companies.


Venture debt can be accessed as either a stand-alone product or in complement to equity financing.


It’s often referred to as ‘risk capital,’ companies that use venture debt do so because they tend to lack tangible assets to use as collateral.


Increasingly, it is being used by bootstrapped companies who struggle to raise funds through traditional methods. These types of companies are lean and understand how expensive diluting equity is in the long run.



Four reasons CFOs choose venture debt


To extend their cash runway


A cash runway is how long it takes for a business to run out of money.


Fast-growing tech companies are rarely profitable. They burn a lot of cash and are always on the lookout for more funding.


Extending a cash runway with debt is ideal. It’s quick, flexible, and allows you to remain focused on development and growth.



As a supplement to equity


If your company isn’t generating enough revenue yet, you may not hit the lending criteria for a 100% debt-based round.


A mix of debt and equity means you get the funding you need, but, with less equity dilution than a 100% equity round.


This is because the risk to the debt lender is much lower, and the VC investment provides that security.


You will read more about lending criteria in part four, but you can skip ahead here.



Because it’s cheaper than equity


Leverage venture debt strategically, and you can eliminate or delay the last round.


This is because if you dilute your shares for a certain price, in a year or two, those same shares could be worth double.


Therefore, by delaying your equity round entirely or by a year or two, you’ll have a much bigger valuation and share of the profits.



For cross-border expansion


Until recently, the finance sector has struggled to keep pace with Europe’s cross-border culture.


Fortunately, venture debt fills the financing gap when scale-up companies want to sell into international markets.


As a result, venture debt has paved the way for a new market of cross-border facilities, offered alongside equity-sponsored financing.


This is even more important for international companies with multiple markets. Having an international debt fund is great because they know the market, they can lend in the same currency, and offer a strategic advantage without taking control of your company.



How you can use the funds


Venture debt provides capital to get through critical periods of growth and cash burn. In some situations, venture debt can also be used to protect a company from a down round which can have a knock-on effect on releasing products, or customers signing up.


But that’s not all.


Find out the most common uses of venture debt loans below:



For mergers & acquisitions


M&A is a great way to gain traction in a new market. Instead of spending millions on developing and marketing a new product, an M&A strategy will allow you to spearhead the market and reduce competition at the same time.  


If you’re interested in using debt for M&A, read this in-depth blog here.



To consolidate shareholdings


You may think a buyback is only used by listed companies, but it is also a common way to spend venture debt.  


Use it to clean up the existing capital structure, return surplus capital to stockholders, and increase the profit per share.


If you’d like to find out more about how to use venture debt for a private company share buyback, read our article here.




To manage a delay


Delays happen all the time. It could be that you come across some unexpected roadblocks when moving into a new market, or a big contract is delayed. A debt round can be useful to help you through an unplanned delay. 


But, if the covid-pandemic taught us anything, it is this. Have enough capital aside so that you can proactively deal with the unexpected. Don’t leave it too late and be out of pocket. 


Rushing to get debt, or any capital for that matter does not put you in a good position for borrowing. 



Growth & profitability


Growth is the most common use of venture debt.  


Use it to fulfill product development or go-to-market strategy, invest in human capital such as sales and marketing, and expand into new markets.  


The objective behind many venture debt deals is often to become profitable during the term of the loan.  




Differences between venture debt and bank debt?


Venture debt funds that sit outside of the traditional bank ecosystem generally have more time and fewer restrictions.  


On top of that, funds offer advantageous sector insights and are responsive to early-stage needs. 


Despite your scaling potential, bank lenders expect you to rack up losses – they see you as a risk.



Three other key differences you should know



The source of the capital


Venture debt investors often include second-time entrepreneurs who are keen to lend a hand to those following in their footsteps. The majority of lending comes from institutional establishments such as insurance companies and pension funds.



The underwriting criteria for venture debt


Compared to banks, venture debt lenders generally have a broader perspective when it comes to underwriting criteria.   


Where banks use a company’s track record of profitability and creditworthiness as underwriting criteria, debt funds look for evidence that companies can repay loans from future equity and enterprise value (customer base, licenses, etc.).  


What’s more, if your company has value in its IP this can also be leveraged to raise funds. 


Like a traditional bank would, debt funds do look at your recurring revenue and turnover, but profitability isn’t the be-all and end-all for debt funds. 


Don’t forget if you’re already backed by a large equity investment from reputable investors, this will also support your chances of getting venture debt financing. 





Bank debt loans come with restrictive covenants and potentially demand personal guarantees from board members and major shareholders. 


It is possible to obtain venture debt with no covenants. However, if there are covenants on venture debt, they are less restrictive than standard banking covenants. That means you can exercise a lot more financial freedom.  


If you want to know more about venture debt covenants, we suggest reading our more in-depth article here



Part 1 summary 


When you compare venture debt to bank debt, the most notable benefits are its flexibility and the fact that for early-stage tech, it is a lot easier to get. 


In part two of the venture debt guide for technology businesses, you can find out the differences between venture debt and equity.  


In the meantime, if you have questions which haven’t yet been answered, get in touch here