When is venture debt right for your business?

If you’ve just started a brand new business, finding the right type of financing is crucial. You’ll need to weigh up all options to help you grow and eventually, scale up.

There are plenty of choices out there, including angel investors, equity crowdfunding and venture capital. But there is an additional option, one that many startups overlook - venture debt.

In this guide, we’ll explore what venture debt is, the pros and cons for startups, and situations in which it could be the ideal choice for your business.

And while you’re exploring financial solutions for your business, make sure to check out the Wise Business account. It’s ideal for companies of all sizes, especially if you have big plans to go global.

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What is venture debt?

If you’re unfamiliar with the concept, venture debt is a loan extended to companies that have already secured equity financing from venture capitalists.

So, you might use it as a bridge between rounds of venture capital funding. It can help to extend your funding runway, which is the operational time you have left before you need to either secure more funding or become profitable.

Unlike a traditional loan, venture debt is typically unsecured. It is closely linked to the future growth potential of the business. It is usually a fixed term loan and may involve interest payments and fees. There’s also something known as warrants, which are options for lenders to purchase equity in the company.

Ultimately, the main attraction of venture debt for startups is access to the capital they need without immediately surrendering any ownership.

Pros and cons of venture debt for startups

Before you enter into any kind of venture debt arrangement, it’s important to understand the impact and implications it may have on your business.

As a starting point, let’s take a look at the main advantages of venture debt for startups, along with the risks, drawbacks and other considerations.

Pros:

• You don’t need to give up additional equity to access more funding. This lets you retain more control over your business.
• The opportunity to extend your funding runway, giving you more time to hit key growth milestones and secure future rounds of funding.
• More flexibility in spending funds. Venture debt can be used for a wide range of purposes, from scaling operations to making large capital investments.

Cons:

• You’ll face pressure to repay. This is the major difference between venture debt and venture capital funding. You need to repay venture debt by a certain timescale, and with interest. This can put pressure on your cash flow, especially if the business is still growing and not yet profitable.
• High interest rates and fees. The costs of venture debt financing can be much higher than for traditional business loans. This can make it the more expensive option in the long run.
• Warrants may reduce your ownership stake. If the funding arrangement involves warrants, this gives lenders the right to purchase equity at a later date. While this doesn’t cause immediate dilution, it could reduce your ownership stake if exercised in the future.
• Covenants to meet benchmarks, with penalties for failure. Some venture debt agreements come with covenants that require the business to meet certain financial or operational benchmarks. If you fail to meet these terms, you could face penalties or be required to repay the debt faster.

When should startups consider venture debt?

There are certain kinds of startups and small businesses for whom venture debt is an effective solution. But it isn’t suitable for all.

Here are just a few of the scenarios in which venture debt could be worth considering:

• Your company is in between funding rounds, and needs more time or capital to reach a key milestone.
• You have positive cash flow but need more capital for expansion, to support key growth initiatives such as hiring, marketing or expanding overseas.
• You need to make specific, significant investments, such as buying equipment or scaling infrastructure.

Are there any alternatives to venture debt?

There are alternatives to venture debt available, even if your startup is experiencing any of the scenarios listed above. It’s worth checking out all options, especially considering the high interest rates and other costs associated with venture debt.

Here are just a handful of other avenues to explore:

• Venture capital or angel investment. Equity financing remains one of the most popular methods for startups to secure funding. While it involves giving up equity, it doesn’t come with the repayment obligations and high costs of debt.
• Convertible notes loans. A hybrid of debt and equity, convertible notes are short-term loans that convert into equity at a later financing round. This option provides the flexibility of debt but with the potential for future equity conversion.
• Revenue-based financing. If your company has consistent revenue, you may be able to take advantage of revenue-based funding. This allows you to repay loans based on a percentage of future revenue, so you can raise capital while avoiding equity dilution and the burden of fixed repayments.

Grow your company and go global with Wise Business

While you’re researching funding options for your startup or small business, it’s also worth making sure you’re set up with the right business account.

Open a Wise Business account and you can hold and exchange 40+ currencies at once.

You can send fast, secure payments to 140+ countries, and get account details to get paid in 8+ currencieslike a local.

Whenever you need to send, spend or exchange foreign currencies, you’ll benefit from the mid-market exchange rate, with low, transparent fees.

You’ll also benefit from all of these features with Wise Business:

• No ongoing fees, minimum balance requirements or foreign transaction fees
• Debit and expense cards for you and your team, which you can use in 150+ countries
• Multi-user access for team members, with ways to control and manage permissions
• Pay up to 1,000 people at once with the Wise batch payments feature
• Integrate with your favourite cloud accounting solutions
• Use the powerful Wise API for automation and streamlining workflow
• Take advantage of Wise Interest to make your funds work harder when you’re not using them (capital at risk).

With a truly global account, you’ll be all set to grow your business worldwide.

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After reading this, you should have a better idea of what venture debt is and whether it could be the right financing solution for your startup.

Just make sure to research and compare all other options first, as there could be a lower cost option that meets your business needs better.

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