Opinion
The venture debt market is growing fast
Striking the right balance between debt and equity can optimize your company's growth and valuation
In the heavily venture capital-funded Israeli start-up ecosystem, where entrepreneurs often race to raise numerous rounds of equity every 2-3 years, equity dilution may seem the best route for realizing ambitious ideas, and sometimes it is. But the picture is a bit more complex than that, and entrepreneurs should be aware they have another option - one that may be better suited for their goals, and which can serve as a cheaper source of financing in the long run.
Guy Navon is the head of Discount Tech. Photo: PR
Startups should bear in mind the long journey ahead. The more a company grows, the more a scalable source of financing and debt strategy become necessary. Startups that generate a hearty amount of revenue and cash flow, and are confident in their future equity fundraising, should consider venture debt as a solution. This article aims to highlight both types of financing equity and debt, so you can make a more informed decision when the time is right.
Equity Funding
Raising equity means you give a piece of ownership in your company in exchange for funds to get you up and running while you’re either pre-revenue or your monthly burn rate is rising to scale.
Options for raising equity include accelerators, angel investors, venture capital, private equity, corporate venture capital, family offices, and other non-traditional forms of equity-based financing.
It’s important to note that venture capitalists and investors generally expect a three to five times return on their investment within five years. If your projected growth rate is different, you may wish to consider additional forms of financing.
Venture Debt
To some extent or another, we’re all familiar with debt. At some point we’ve all probably at least had a student loan, a credit card, or an auto loan or lease. Debt means you are taking out a loan. When it comes to your startup, the most obvious advantage of using venture debt is less dilution and added flexibility with spending. Your business is in your control. Your holdings stay intact. Founders get to make the decisions, as well as keep the profits.
The venture debt market is growing fast
Many entrepreneurs recoil at the word debt, but for VC-backed companies that already have initial revenues, the upsides can far outweigh the risk. Typically, you can use venture debt to increase liquidity or extend burn, or to finance certain assets. According to Pitchbook, in the US, venture debt is growing faster than the broader VC market.
Banks offering venture debt do take business collateral, but once they provide the backing, they’re usually in it for the long run, and even in the case the business encounters a rough patch, they will be there to offer the best solutions to get you back on track.
- LeumiTech CEO: For companies raising capital, “the cost of debt becomes negligible”
- J-Ventures Investor Conference kicks off second year with an emphasis on Impacttech
- Cybersecurity startup Grip raises $19 million in Series A nine months after founding
Reaching a Value Milestone
For startups, certain financial milestones, such as $5 million in annual recurring revenue, create a variety of new investment and exit opportunities. Venture debt can give startups the breathing room they need to reach a key value milestone before raising that next round.
Moreover, startups raising an equity round take on a layer of debt at the same time, ensuring their equity becomes more efficient. This is highly beneficial for entrepreneurs seeking to grow faster without having to dilute their holdings at every round. As a rule of thumb, equity raised with a layer of debt opens up more options for a higher valuation at the exit or IPO.
Summary
Tech companies, whether they measure success through service subscriptions, revenue recognition, or SaaS metrics, should add a potential debt strategy to their plans. It’s also important to keep in mind that you can adopt a hybrid approach to financing, leveraging both equity funding and debt financing.
Guy Navon is the head of Discount Tech.
