When to Use Venture Debt

When it comes to funding a startup venture debt offers a promising way to fuel growth while retaining founder equity, but can spell doom if used improperly. Outlined in this article is when and how to use venture debt at different stages of a venture.

Cash Flow Negative Ventures

Very few early stage ventures are credit worthy. Most have little to no assets and are likely burning large amounts of cash. When it comes to these startups, lenders are typically loaning against the credit-worthiness of the VC’s backing the venture, rather than the venture itself. Instead of relying on the capacity of the startup to repay the loan, they are relying on their ability to secure a subsequent round of funding that services the loan and repays the principal.

Since lenders are largely evaluating your startup’s fundraising ability , they will conduct their due diligence similar to how a VC analyzes a venture. In turn, most early-stage venture debt raises happen immediately after a new equity round. It is at this point that diligence data is fresh and a startup’s ability to fundraise is evident.

There’s a number of uses for venture debt when you are still burning money , all of which revolve around extending your runway until your next milestone. This is why you must have achieved product-market fit prior to raising early stage venture debt. Pivoting between rounds can often result in the need for a bridge round that isn’t adequate enough to repay your venture debt, resulting in a potential default.

Cash Flow Positive Ventures

When it comes to growth stage companies, the burden of creditworthiness shifts from the VCs to the startup itself. At this point a startup will likely have the cash flow to pay off the debt on their own, or at least have sufficient assets to adequately collateralize the loan. Since the debt is no longer tied to the startup’s ability to fundraise, growth stage venture debt can be issued at any point between or during funding rounds rather than being issued in conjunction with a round.

Upon reaching profitability, runway is of no longer concern. At this point venture debt is used to make large inventory/equipment purchases, company acquisitions, or simply to scale faster with minimal dilution. With the increasing prevalence of unicorn companies, late-stage venture debt is a growing and lucrative form of capital

What Next?

When it comes to growth stage companies, the burden of creditworthiness shifts from the VCs to the startup itself. At this point a startup will likely have the cash flow to pay off the debt on their own, or at least have sufficient assets to adequately collateralize the loan. Since the debt is no longer tied to the startup’s ability to fundraise, growth stage venture debt can be issued at any point between or during funding rounds rather than being issued in conjunction with a round.

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