Venture debt or venture lending or "venture leasing" is a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund working capital or capital expenses, such as purchasing equipment. Unlike traditional bank lending, venture debt is available to startups and growth companies that do not have positive cash flows or significant assets to use as collateral. Venture debt providers combine their loans with warrants, or rights to purchase equity, to compensate for the higher risk of default.
Types of venture debt
Venture debt is typically structured as one of three types:
- Growth capital: Typically term loans, used as equity round replacements, for M&A activity, milestone financing or working capital.
- Accounts receivable financing: borrowings against the accounts receivable item on the balance sheet.
- Equipment financing: loans for the purchase of equipment such as network infrastructure.
The venture lender effectively piggybacks on the due diligence done by the venture capital firm.
Venture debt lenders expect returns of 12–25% on their capital but achieve this through a combination of loan interest and equity returns. The lender is compensated for the higher rate of perceived level of risk on these loans by earning incremental returns from its equity holding in companies that are successful and achieve a trade sale or IPO.
Equipment financing can be provided to fund 100% of the cost of the capital expenditure. Receivables financing is typically capped at 80–85% of the accounts receivable balance.
Loan terms vary widely, but differ from traditional bank loans in a number of ways:
- Repayment: ranging from 12 months to 48 months. Can be interest-only for a period, followed by interest plus principal, or a balloon payment (with rolled-up interest) at the end of the term.
- Interest rate: varies based on the yield curve prevalent in the market where the debt is being offered. In the US, and Europe, interest for equipment financing as low as prime rate (US) or LIBOR (UK) or EURIBOR (Europe) plus 1% or 2%. For accounts receivable and growth capital financing, prime plus 3%. In India, where interest rates are higher, financing may be offered between 14% and 20%.
- Collateral: venture debt providers usually require a lien on assets of the borrower like IP or the company itself, except for equipment loans where the capital assets acquired may be used as collateral.
- Warrant coverage: the lender will request warrants over equity in the range of 5% to 20% of the value of the loan. A percentage of the loan's face value can be converted into equity at the per-share price of the last (or concurrent) venture financing round. The warrants are usually exercised when the company is acquired or goes public, yielding an 'equity kicker' return to the lender.
- Rights to invest: On occasion, the lender may also seek to obtain some rights to invest in the borrower's subsequent equity round on the same terms, conditions and pricing offered to its investors in those rounds.
- Covenants: borrowers face fewer operational restrictions or covenants with venture debt. Accounts receivable loans will typically include some minimum profitability or cash flow covenants.
- Venture debt in Europe IN VIVO Blog Spot, 25 June 2007.
- The Rise of Venture Debt in Europe BVCA and Winston & Strawn, May 2010.