Venture debt could be the answer for high-tech and innovative young businesses looking for funding to underpin the next stage of their growth. Many such businesses wrongly assume that equity finance is their only option if they want to raise finance, but venture loans are a potentially attractive alternative.
It’s certainly the case that fast-growing young businesses with a limited trading history and little or no track record of profitability usually struggle to borrow money from conventional sources, even where they have exciting prospects. Banks are generally wary of the risks posed by these start-ups and tend to steer clear – in fact, Bank of England statistics show that bank lending to all SMEs has been falling over the past year.
Very often, business founders believe this leaves them with little choice but to raise equity capital in order to fund future growth – and to give up a large chunk of ownership in the process, possibly even ceding control to their investors. But debt finance may still be available to start-ups with a viable business model and strong growth prospects: venture loans are aimed at exactly this sort of company.
Features Of Venture Debt
The venture debt available from non-bank lenders such as BOOST&Co combines the traditional features of a loan with aspects of the venture capital that has traditionally been the preserve of investors offering equity finance. It’s potentially attractive to start-up and growth companies that do not yet have the sort of positive cash flows that banks look for, or the valuable assets that banks typically expect borrowers to put up as collateral against their borrowing.
That’s not to suggest venture debt is suitable for start-ups with no track record at all, or no significant revenues or assets. Lenders will want to see that the business is already generating strong revenues – BOOST&Co, for example, looks for a revenue rate of £5m; they will also assess the business’s enterprise value, as well as making a judgement about its future growth prospects.
Nevertheless, because venture debt providers are interested in the current and expected performance of a business – rather than its historical financial performance –this sort of funding is open to young and relatively immature businesses, even though bank finance may not be an option.
Venture Debt Pricing
Venture loans tend to be priced individually, depending on the needs and circumstances of the borrower – companies at an earlier stage of their development or with a faster cash burn rate, say, would typically expect to pay more. But this type of debt typically incorporates three elements: a fee of between 1% and 2% of the loan approved, an annual interest rate of between 10% and 12% in the current marketplace, and an equity kicker worth 10% to 20% of the loan. This final element is typically structured as a warrant giving the lender the right to buy a small portion of equity at a fixed price during the term of the loan.
In BOOST&Co’s case, venture loans vary in size from £2m to £8m and are typically repayable over terms ranging from 36 to 60 months. But the loans can be structured in different ways to suit the borrower. Some companies choose to draw down funding in tranches as and when they need the money, which reduces the total interest cost. And while repayments usually include both interest and capital, some borrowers opt for an interest-only period at the beginning of the loan – for six to 12 months, say. Some loans include covenants the company must meet, but others don’t.
Clearly, venture debt isn’t suitable for every young business. But while it is a more expensive option than traditional bank finance, it does offer many fast-growing but immature companies access to debt finance; for those businesses whose preference is for this type of funding over equity capital, venture debt is therefore worth investigating.
This is an excerpt from our white paper, download The Growth Lending Guide to learn more and discover how Growth Capital can help your business growth without equity-loss.