If you are planning to look for funding for your startup, you might have come across the term “venture debt” or “venture capital financing.” What are these, and how does this help my startup when it comes to funding? We’ve written a simple yet comprehensive guide to walk you through this concept and help you determine if this is something your startup would need.
Funding Your Startup
It is an open secret that running a successful business depends not only on having a wonderful vision or idea, but also on having the necessary funds to execute one’s vision; they must walk hand in hand. After all, you may have the next great idea that will disrupt the traditional way of doing things, but if you do not have the means to turn it into a reality, it all becomes a pipe dream that never comes to fruition.
Therefore, having cash in hand is crucial, especially for emerging startups, as they want to establish their presence in the market, increase market share, and improve their product or services for customers. Doing so does not come cheap; startups need to hire the right employees to assist in product development and marketing. Often, these startups offer promos or discounts to lure customers. It is not uncommon for startups to operate at a loss for the first few years due to these marketing tactics to gain market dominance and be profitable in the future.
There are a few options to collect capital and funds to keep one’s startup operational. Fundraising and obtaining the backing of angel investors or venture capital can be options, but remember that each comes with its own pros and cons. The route less travelled is asking for a bank loan, since applying for it requires extensive operating history and total assets owned, both of which startups do not have. As time passes, however, the tide has seemingly changed with venture debt financing entering the picture.
What is Venture Debt Financing?
Venture debt financing enables startups to tap another source of cash and capital. It functions as a complementary component to your existing venture capital. The amount of loan received will typically range from 10 to 30% of the sum you have successfully raised during the previous financing or fundraising stage.
Unlike a bank loan that requires a business’s collateral to be eligible, a venture debt lender will get warrants on the business’s stock, meaning that it can be purchased at a predetermined price once it goes public. This is a far more favourable arrangement since startups usually do not have many business assets. However, similar to a bank loan, the loan must be repaid with interest within the agreed timeframe. Failure to do so will likely result in liquidation and bankruptcy, meaning you are obligated to pay your lenders first after it occurs.
The COVID-19 pandemic has led to venture debt being embraced by the masses, as it provides access to cash and funding when the economy and supply chain disruptions worldwide cause a significant drop in sales. The global market size for venture debt reached US$28.2 billion, a figure that is predicted to keep on increasing in the years to come as it becomes more mainstream.
Why Choose Venture Debt Financing?
Embracing this route to add your business’ cash brings the following benefits
- You are still in control
More often than not, when you invite a venture capitalist to fund your startup, they expect to be compensated by gaining equity in your business. This means that they will essentially have a stake and a say in how the business operates. It is also likely for them to appoint someone experienced to be a representative on your Board of Directors and guide you in the day-to-day operations. In stark contrast, venture debt lenders will not want to be involved in the daily decision-making of business operations. All they care about is getting their loans repaid on time with interest. This gives you more autonomy and ensures that your shares remain intact.
- Extends money runway
Continuous cash flow is necessary for startups to grow and stay competitive. By approaching venture debt lenders, startups have access to additional money to survive without giving away equity. The money can be used to reach key milestones and drive a higher valuation for the subsequent fundraising round. Doing so will make the startup more viable for the long haul.
- Easier to obtain
Venture debt lenders are not reliant on past performance or existing assets to determine whether your startup is a prime candidate. They put more emphasis on your future potential growth and the existing investors or VCs that backed you, so the due diligence process is much faster than with a traditional bank loan.
Disadvantages of Venture Debt Financing
As with every funding option, venture debt financing also comes with its disadvantages:
- The possibility of defaulting
Although venture debt lenders give you more freedom than venture capitalists, several requirements still need to be fulfilled to maintain the agreed loan, such as expansion and growth figures. If this is not met, they are within their rights to ask for their loan to be repaid in full right away, including the accrued interest, making your startup default.
- The fear of liquidation
Upon defaulting, your lenders may expect to be reimbursed right away, and you may not have adequate cash to repay them. Once this stage is reached, your only option is to liquidate your assets and business, declaring yourself bankrupt. The sale proceeds are then given to the lenders. After all, debts must be repaid, which differs from venture capitalists’ funding.
- Interest must be paid
Venture debt financing means you must pay the interest accrued during the loan term, making the total amount paid to lenders exceed the amount you borrowed.
Venture Debt Financing in Singapore
The Singaporean government first introduced the idea of venture debt by establishing a S$500 million Venture Debt Programme (“VDP”) to provide startups and small-medium sized enterprises (SMEs) an additional financing option for business growth and expansion. This was followed by the major Singapore banks, such as DBS and United Overseas Bank (UOB), taking a plunge into the venture debt financing space. UOB even formed a joint venture with Temasek, Innoven Capital, to support such endeavours.
The increasing number of businesses leaping into the space is not without reason. As venture debt financing comes in tandem with the total amount of equity raised, the space has enormous potential to keep growing, similar to the figures of startup fundraising raised in Singapore that keep on climbing each year. Read our comprehensive guide for fundraising in 2022.
As one of the leading technology firms that provide end-to-end financial services and solutions for businesses, Lanturn has a proven track record in fulfilling every client’s needs. This includes helping clients navigate their accounting and financing needs. Lanturn has a proven track record in administering over S$200M in fundraising rounds for our clients, from initial seed rounds to Series C.
Lanturn can help your fundraising rounds go smoothly. Contact us now.
