One thing that does matter to CFOs and FDs is the outlook for the business successfully completing an equity round in the future and using that prospective event to repay the debit facility. Or, at least, having the option to repay in that time window.
Venture Debt providers are sensitive to the growth rate, and perhaps the unit economics of the prospective business, and will consider these criteria to screen for an offer of a venture debt facility. In addition, knowing the investors already on the cap table of the business is important as well as what their position is on the prospects of the company. Essentially venture debt in this space is readily available when your investors have a strong track record and indicate they’ll be supportive of the business in question.
Many of these deals happen at the same time, or shortly after an equity round has occurred. And this is because the investment hypothesis is that the venture debt is contributing to the same funding window as that equity round.
Some very positive features include the debt being covenant-free, this is a huge advantage where a business is not yet predictable and avoids showdowns later down the road if certain figures are not achieved. It’s popular as a compliment to an equity round and the main appeal is to extend the funding round, without that extension giving you a directly proportionate impact on dilution for the existing investors.
Interest rate brackets have historically been 8-10% when the provider or bank is lending off its own balance sheet and that can help them to be competitive on pricing. The market has expanded and there has been the entrance of a few new entrants, and that competitive pressure can bring that down to nearer 7% on occasion, although these things vary year by year.
One of the necessary forms of rewards that a Venture Debt lender requires is warrants. These warrants are not too different from a share option, they have a strike price and need to be exercised in certain scenarios, normally at exit. It’s essentially a part of the upside for a Venture Debt provider and many of the banks communicate this mechanism is necessary for the provider to offset the downside of some defaults in any portfolio.
For Tech CFOs the appeal of this sort of offering is that many of these deals will deliver an option for the company to draw over a period of, say, six months. This helps where there could be some uncertainty on if the Venture Debt is really needed to extend the runway of a business. In this type of “insurance-policy” construction keep in mind that the provider may have tranched the warrants. This means that in a situation where a deal is done, however, the drawing does not occur, an agreed slice of warrants will go to the provider solely for the value-add of having had this capital at their fingertips.
The repayment profile of any of these offerings will need to be planned for and it would usually be 30 to 36 months when repayments need to be made. However, a statistically relevant proportion will be repaid via a later equity round or rolled up into a new venture debt agreement subsequent to a later equity round.
With venture debt there can be a bunch of fees included in these arrangements, both at the start of the loan and also at the back-end of the deal, in the form of a maturity fee. And if you are in such a good place the company repaid early there will often still be a prepayment penalty that is likely to be a sliding scale depending on which point in the product lifetime the repayment occurred.
Security over assets and IP is fairly standard for a venture debt deal. Sounds a bit scary but this is essential from the provider’s standpoint to ensure something as valuable as that could not be transferred to another party at any point in the duration of the arrangement.
Overall this type of debt finance should not be ignored, the ticket sizes are substantial and these debt products can add many months to the runway if you can accept that the fees and warrant dilution are a price worth paying for the additional time on the clock.
