· venture debt,fund raising,funding instruments,alternate funding,capital

In this series of blog posts, we would discuss different fund raising instruments that a firm could explore.

Apart from many factors that would play a role in the decision, I consider the below three as the most important:

  1. Need for capital: Is the capital required for long-term growth or short-term working capital?
  2. Nature of Cash flows: Are my cash flows stable, positive and predictable?
  3. Stage of Firm: Are debt options available for my stage of firm and at what cost?
While I was looking for an elegant way of representing the entire gamut of options, I bumped into this article (https://tinyurl.com/y8ey53kg) and the below beautiful illustration:

Apart from the above, other options are NCDs (Non-Convertible debentures), OCDs (Optionally Convertible debenture), Impact bonds and of course there are numerous Grant options available…

Venture Debt
The first instrument / option that we would discuss in this post is Venture Debt.

Venture debt is generally a non-collateral based debt, available to venture backed growth stage startups. As could be seen from the illustration above, it is a debt form of funding with an option to participate in equity upside through warrants.

 
Let’s look at to which profile of firms does Venture debt most fit basis the above mentioned three factors:
 

Stage of Firm: Growth stage (~>40%), steady / high visibility to revenues, path to profitability ideally within 12–15 months

Usage of capital: Venture debt is meant to augment equity and provide impetus to growth. It is generally advisable to not go for venture debt for financing short term working capital needs.

Cash flows: Predictable positive cash flows to service the debt.

  Advantages:
  1. Venture debt helps to reduce dilution. I love this illustration from Trifecta on this:

2. It augments equity capital — increases runway

3. Increased time to build leads to a higher valuation possibility

Pick of sectors for Venture Debt

SAAS firms (dependable recurring revenue), B2B product firms (long-term contracts, high lifetime customer value).

Closing comments: The fundamental ability of the firm to grow and to honor the cash flows of venture debt is very important. Timing of drawing the debt is also an important factor — shouldn’t be too close to funding, neither should be too late.

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