Venture Debt 101: Your Top 4 Questions Answered

♦ What is venture debt and how is it different to bank and venture capital investment products?

Venture debt is a non-dilutive investment solution aimed at high-growth businesses with revenue run rates in excess of £3 million, and a business model with excellent growth potential. It combines the traditional features of a loan, with aspects of venture capital and equity finance. Essentially, this means that venture debt lenders will look at the future growth prospects of a company, rather than its historical financial performance.

Also known as growth or private debt, this type of funding is provided by specialist growth lenders earlier and in larger amounts than traditional banks. This provides additional options to SMEs that fall between early-stage venture capital and later-stage bank lending.

Venture debt provides an attractive alternative to businesses with a limited trading history and record of profitability that want to avoid dilution or the loss of control, as it does not require direct involvement via board seats or equity. Nor does it make management teams personally responsible for funding via covenants or personal guarantees. Loans can be structured in the way that best suits the businesses, with funds provided as a lump sum or in tranches. Regardless of industry, growth, or exit strategy; venture debt enables businesses to reach their growth objectives while maintaining control and equity.

♦ How can I prepare my business for venture debt?

Venture debt investments are provided in the form of loans – generally of between £1 million and £10 million – so companies considering venture debt as a potential growth capital solution need to ensure that their business is able to generate enough cash to service the debt repayments, or that there is a clear path to a future round of funding.

From a management perspective, companies seeking venture debt funding need to ensure that they have a strong and diverse management structure in place. Successful management teams have a balanced view of their performance and rely on a diverse team of individuals for decision making.

♦ What are venture debt investors looking for, and what are the factors that lenders use to identify and filter potential investments?

In contrast to equity capital and bank debt, venture debt growth capital protects the equity of existing shareholders, provides a lower cost of capital, and delivers a faster funding process. It is important to note, however, that this debt must be repaid over a predetermined fixed term, which can impact on business cash flow. Thus, when meeting with investors, it is important for companies to be able to show strong growth momentum.

Unlike traditional banks, growth capital lenders look at future growth potential rather than past performance. Businesses applying for funding should, therefore, develop clean, robust, and realistic financial forecasts. These should include a fully funded business plan, achievable forecasts, and clear assumptions on funding, KPIs, revenue build-up, cost structures, and working capital dynamics.

As the controlled risk profile of businesses at the scale-up stage is particularly well matched to growth debt, companies should highlight scaling opportunities. These should indicate that the business model is proven – an important factor for venture debt lenders – and needs additional resources to grow via strategies such location expansion, increasing staff numbers, or investment in production capacity and product development.

To increase their attractiveness to venture debt investors, companies should provide attractive but realistic business plans that show how the debt can be serviced. Businesses should also be able to provide good visibility on downside protections factors, including future revenues, potential cost reductions, assets that could be liquidated, and potential third-party buyers.

♦ How, can I use venture debt to grow my business, and what level of support do venture debt lenders offer?

Venture debt can be used to fund a number of growth strategies, including but not limited to:

  • The roll-out of new sites
  • Extending a business’s cash runway
  • Providing working capital
  • Increasing staff numbers
  • Marketing and sales expansion
  • Product development
  • M&A activity

Since growth capital lenders invest in companies that already have a proven business model and that have reached the point of scalability, they do not require direct intervention in management and take no board seats or voting rights. However, based on their investment and market experience, exposure to large numbers of organisations at the growth stage, and relationships with other investors and industry players; venture debt lenders are able to provide support in the form of mentoring and guidance and introductions.