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A guide to Venture Debt

Critically, as debt capital it’s significantly cheaper than equity financing, providing a lower cost extension to the VC fundraising round and as such fuelling further growth.

High growth small and medium-sized enterprises (SMEs) are at the heart of the UK economy, driving innovation and job creation across the country. Often backed by venture capital (VC) investors, these high growth businesses frequently suppress profitability and instead prioritise investment for scale and market capture. Such companies have complex financing needs, which typically cannot be catered for by traditional bank debt.

This is where Venture Debt can make a difference: provided by specialist lenders and a handful of banks, it offers an alternative debt solution that is complementary to VC equity financing, enabling entrepreneurs and management teams to take their businesses further, faster and with less to no dilution of equity. 

Simon Foss, Vice President, Venture & Growth Finance, NatWest

What exactly is Venture Debt?

When startups are investing for growth, they will often plan their funding around achieving key milestones. Once these milestones are met, the business should have increased in value and therefore be in a position to raise further equity at a higher valuation.

Typically, high growth SMEs use VC equity to support that growth journey, accepting that it results in a dilution for the founder/s and existing investors. Venture Debt (sometimes known as Growth Capital) works differently. It’s a form of flexible debt financing, tailored to the unique needs of high-growth, VC-backed SMEs (typically Series A+) and designed to work in tandem with VC equity and top-up an equity round. Critically, as debt capital, it’s significantly cheaper than equity financing, providing a lower cost extension to the VC fundraising round and, as such, fuelling further growth.

How is Venture Debt different from traditional lending?

Lenders of traditional lending products assess debt serviceability against a combination of the near-term future cash flows of a business, material physical assets, or short-term receivables (e.g. company invoices). A scale-up business that currently prioritises investment in growth ahead of profit is still in ‘cash burn’ phase and often lacks material tangible assets. It’s therefore usually out of scope for such traditional products. Rather than looking to current or near-term cash flows or asset financing, Venture Debt instead places a higher emphasis on: the equity raised by a business, the IP created, stability and scale of its revenue line, and its going-concern value.

Why raise Venture Debt?

The benefits of raising Venture Debt as opposed to further equity is that debt will provide a substantially cheaper cost of capital and will not dilute (or dilute to a lesser degree) the existing shareholder(s). Essentially it will enable an extension of a borrower’s cash runway at a substantial price discount to a further equity raise. Further benefits include a faster transaction process and minimising loss of control, with many debt providers not seeking a Board observation seat.  

When is the best time to raise Venture Debt?

Concurrent to a Series raise: You may be looking to top-up an ongoing equity raise and see debt as an option to do so without further diluting your shareholding or to extend the potential use of funds for a funding round, as a Venture Debt provider may be more flexible in permitting what funds can be used for (e.g. acquisition funding, legacy shareholder distributions/buy-backs). Securing both forms of funding in tandem will increase bargaining leverage for the borrower and may speed-up the process, given all the information will be available in a data room and all funding conversations can be had in parallel. 

Between Series round extensions: Whilst the forecast at the outset of the previous Series round may have demonstrated that a business would hit milestones within a given period, things do not always go as planned. Overperformance can require additional working capital support, capex, or building teams in new jurisdictions. Or, a delayed contract signing (especially at the enterprise end of the market) could impact cash flow or runway. Rather than reallocating internal resources or looking to internal or external investors for an interim round, Venture Debt can be a bridge to the next equity raise, or simply provide the additional liquidity needed to manage downside scenarios, without dilution or valuation discussions.

What are some specific use cases for Venture Debt?

Venture Debt providers are typically very flexible in how the funding can be used, but common use cases include:

  • An equity raise to make a fundraise go further or as a potentially unutilised ‘insurance’ for future shortfall in the cash runway
  • Organic growth from investment in capital expenditure
  • Out-of-cycle opportunities including M&A that can be addressed rapidly without an equity raise
  • Runway extension between funding rounds, thereby avoiding a bridging round or down round
  • Bridging to profitability without further investment from existing investors or further dilution for founders
  • Working capital, to fund and smooth fluctuations
  • Various recapitalisations including selective support for secondaries, re-finances, and employee ownership trusts

Find out about Venture Debt in more detail

Venture Debt is an emerging and evolving product within the European scale-up ecosystem. Hopefully this is a helpful initial primer for Venture Debt, but it is certainly not an exhaustive guide, and there are many other considerations, structures, options and concepts not covered.