How Does Venture Debt Funding Work for Start-Ups?
Debt is cheaper than equity they say. Is it really? Find out the what, when, why of venture debt form of funding for your SaaS start-up.
It’s no secret that businesses need capital to get up and running. There are numerous sources to get funding from, be it bank loans, IPO, or even asking your friends and family for funding for a share of the business equity. One of these sources is venture debts.
So what is venture debt? How can venture funding help a startup business in its funding needs? What are the risks and benefits that come along with venture debt?
Venture debt funding offers a company fresh capital in the form of debt. This helps reduce the amount of dilution of equity the company faces when they're starting out.
In numerous cases, authors have given away a chunk of their business share to investors during seed rounds and Series A rounds of backing, but they may still need fresh capital to expand further, run announcement campaigns, or produce other means for growth. Rather than diluting more of equity of their business, they can add venture debt to their stack, which saves dilution for an unborn Series B round of backing.
Venture debt is generally structured as a traditional term loan with fixed yearly interest payments over 1-3 times. Some lenders, like Flow Capital, offer flexible structures that are acclimatized to meet the unique requirements of each company.
How is venture financing different from bank loans?
Banks and other financial institutions provide loans based on the past cash flow of the business or against some asset as a collateral, just in case things go wrong. But venture funds are provided based on the ability of the business to raise further funding.
The business in return provides a Non Convertible Debenture(NCD) to the lender of the funding. Furthermore, the lender might fix an amortization period, typically one or two years, where they receive only the interest of the principal amount.
What are the benefits of venture capital?
So, without a financial complaint, why would startups sign a business loan? First of all, it is a simple supplement after increasing business revenue and can significantly help you expand your existing rise without much stop. You have your resources in order, new information in your mind and you have a supportive growth plan you are working on.
But the great advantage is that debt is cheaper than equity, and it always will be.
Although the price of equity varies based on your calculations, business credit increases equity to take credit on better terms than what traditional lenders — notorious for emerging software companies — can offer. Also, venture financers do not take board seats, so less equity is diluted.
Venture funding can benefit both the borrower and the lender in numerous ways. Some of them are:
- Minimal Equity Dilution: Since venture debt lenders don’t take on board seats, there’s less equity dilution.
- Enhance Liquidity: The businesses balance sheet will look more appealing as the liquidity of the firm increases
- Increased Valuation: As the debt increases the liquidity in the balance sheet, it also increases the valuation of the firm
RISKS RISKS RISKS!
Nothing in this world is without risk, let alone borrowing a lump sum amount of money. Before funding is provided, the business will provide a set of metrics, projecting its future growth. If the business doesn’t grow to the metrics promised, the funding might be pulled, causing the business to be left in an awkward position.
Taking too much funding can over leverage the firm, and can discourage further lenders from providing any form of funding. It would be a situation where they would be funding the firm to pay back someone else and that’s not a favorable situation for any lender.
Venture debts are associated with extensive security measures to protect against the risk of loss. Borrowers also receive institutional support and are quickly confronted with corporate governance and integration.
The return on a linked account is a combination of fixed interest payments and potential appreciation in value from collateral. This is a high yielding salary and an attractive option that contrasts with the low yielding issue investors are currently facing. Most importantly, these incomes are natural, not alien.
Likewise, despite reasonable rewards, investors are interested in the potential value benefits of portfolio institutions because they value these organizations. The commitment to venture funding acts as a gateway for investors to participate in the corporate environment in a structured manner.
To wrap it up…
Venture funding can be a great way to get your business started, with all its perks and scope for growth. But with the risks attached, thinking a few steps ahead wouldn’t hurt the business. If you’re a small or a mid-sized business looking to grow, venture debts give a chance to lay a solid foundation, realize their potential, and accelerate growth for future stock finance cycles.
Obviously, finding the right venture capital lender is very important. Make sure you research all of your options, carefully review the terms and conditions, and find a lender who can offer wise advice.