Q: What is Venture Debt?
A: Venture debt is a complement to venture capital where venture capital backed companies can secure a growth capital loan and borrow money even though they would not otherwise be creditworthy from a traditional banking perspective. Start-up companies use debt to leverage the venture capital equity they have raised, thereby extending the time needed until their next round of financing.
Debt is considerably less dilutive than equity and by financing certain expenditures; companies can save their expensive and dilutive equity dollars for other uses. Typically companies can secure term loans for as much as 40% to 50% of the equity that they have raised.
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Q: When should I consider venture debt?
A: It is best to consider putting a credit facility in place when the company still has cash; therefore, shortly after closing a round of equity financing. It is important to look at your company’s capital needs as a whole, considering how much capital is required immediately as well as over time, and considering how much equity versus debt thereby meeting your company’s needs while maintaining minimal dilution.
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Q: Why should I avoid financial covenants in my credit facility?
A: Typically a credit facility provided by a bank is layered with covenants. Covenants can impact the operations of the company because management must operate the business to remain in compliance with them.
Covenants are restrictions under which a company must operate in order to borrow money or keep an outstanding loan balance. They may require a company to maintain minimum cash balance, meet certain financial ratios, raise equity by a specific date, or meet other operating milestone.
Often times, covenants severely restrict the usefulness of a credit facility. For example, if a covenant requires the borrower to maintain a minimum cash balance of $3 million at all times, the borrower’s $5 million credit facility really provides only $2 million in usable incremental cash.
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Q: How are loans secured?
A: Growth capital loans are generally secured by a lien on all assets of the company (blanket liens). Specific asset liens are common for capital equipment financing lines. All-asset liens typically include liens on a company’s intellectual property.
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Q: Why is a partner’s ability to provide both debt and equity important?
A: It is important to partner with a firm that can grow with your company. One that can provide venture debt currently and then in the future can also participate in your next round of financing. A partner that doesn’t look at the financing as a fixed term relationship but instead looks at it as a financing that is a long-term relationship focused on building a successful business.
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