Venture Debt — Alternative for Early Stage Companies?
For some time now, start-ups have had access not only to traditional equity financing and mezzanine instruments, but also to debt financing comparable to a bank loan — venture debt. This opportunity for companies to raise new capital, which until then had been served almost entirely by conventional banks, is increasingly opening up to companies whose ratings make it difficult for them to prove their creditworthiness to conventional financial institutions.
In the USA, unlike in Germany, the share of SME financing borne by banks is much more evenly distributed between banks and other lenders, especially debt funds. Like private equity funds, debt funds raise capital from investors and lend it to companies, either simply as working capital or as growth financing to finance the acquisition of other companies or individual assets such as real estate or industrial property rights.
Venture debt must be distinguished from other debt instruments, in particular private debt on the one hand and from equity financing of start-ups, i.e. classic venture capital, on the other. Venture debt is the provision of outside capital to start-ups, primarily through investment funds.
Since young companies usually do not have access to traditional financing from banks due to a lack of creditworthiness, venture debt funds close this gap by granting loans as growth financing to young companies. Venture debt is characterized by regularly short to medium-long maturities and an interest rate commensurate with the risk of the investment and is consequently attractive for companies that have outgrown the start-up and early growth phase with equity financing, but either do not have sufficient collateralizable assets or do not yet have a positive cash flow and thus do not have access to classic financing instruments. Venture debt funds are able to disburse loans quickly and pragmatically and to structure them flexibly.
In the eyes of the founders and existing shareholders, venture debt is a way to provide the company with capital without diluting the existing stake. The advantage is that debt financing does not require a current valuation of the company. By contrast, this advantage is relativized if the debt financing is concluded together with an equity financing round. Finally, unlike venture capital funds, debt funds do not usually require a seat on the company’s advisory board.