Venture debt could be the ideal type of finance for fast-growing SMEs in the flexible workspace sector
Could venture debt be the ideal solution for small and medium-sized enterprises in the co-working space sector? SMEs operating flexible workspaces, where tenants pay for shared office accommodation on a month-by-month basis rather than signing up for long-term leases, are well-placed to expand quickly given the strong growth drivers in this sector – but only if they have the right funding in place to support this expansion.
At first sight, the business model underpinning co-working is deceptively simple: get one or two locations up-and-running, bring in enough tenants to move towards profitability, diversify the revenue stream by offering additional services to those tenants, then repeat the trick at the next location. In theory, it should be possible to roll out new sites rapidly, building a sizeable business in a relatively short space of time – the US giant WeWork, for example, has acquired 100,000 members in 16 countries around the world within just seven years of its launch.
However, while co-working operators with a handful of successful sites have a proven and scalable business model, they require funding to put theory into practice. The upfront costs of each new site are high, with both leasing charges and refurbishment expenses to manage. Revenues, meanwhile, only begin to flow once tenants have been secured, and begin paying rents and purchasing additional services.
For this reason, co-working operators unable to secure finance are unlikely to deliver rapid organic growth rates. In which case, what sort of finance is most suited to the flexible workspace business model?
Venture debt is a potentially neat answer. Available to SMEs that are still at the pre-profit stage of development, this is capital that comes in larger amounts than would be available from a bank, even assuming that conventional lenders would be prepared to make an advance at this early period in the life of the business.
Venture debt providers look for businesses that have already achieved some scale, rather than outright start-ups, with a particular focus on SMEs with proven business models that are already generating repeatable revenues. They make a return on their capital through interest and fees charged on the debt, as well as from equity upside, typically secured through warrants.
That model is a good match for an early-stage co-working business. With one or two sites functioning effectively, such firms can show they have a viable business model. The rents paid each month by tenants, meanwhile, provide the venture debt provider with the visible revenue streams it expects to see.
Venture debt offers co-working operators potentially valuable flexibility. For one thing, the debt can be drawn down in tranches, as and when it is needed – for each new site opened, say – so that the company pays charges only on the funding it needs. Often, the debt is structured with a six to 12-month interest-free period, which can be useful to co-working operators in the early days of a new site when they are likely to have fewer tenants.
Many co-working operators will also welcome the relatively small amount of equity incorporated in venture debt arrangements. Many businesses in the sector have financed their growth primarily through equity investment but, given the rate at which the most successful co-working operators have shown they are able to build equity value, giving up too much too early may be a painful prospect for founders.
For all these reasons, venture debt is a potentially good match for co-working businesses looking to grow rapidly. In a fast-moving sector where competition is increasingly tough – both for new tenants and the best sites – putting such funding in place may be the key to securing the advantage.