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.