How Startups Use Venture Debt
Venture debt, a core SWIFT SBF business, is designed for high-growth startups.
When is venture debt right for you
Venture debt is widely discussed in startup circles, but is often misunderstood. We work
with nearly half of US venture-backed tech and life science companies. If you are a
growing, venture-backed startup, find out if venture debt may be right for you.
How Venture Debt Works
Venture debt is a loan designed for fast-growing investor-backed startups. It most often is secured at the same time or soon after an equity round—and is typically used to extend runway to the next round.
Startups benefit in several ways: Venture debt reduces the average cost of the capital to fund operations when a company is scaling quickly or burning cash. It also provides flexibility, since venture debt can be used as a cash cushion against operational glitches, hiccups in fundraising and unforeseen capital needs.
Venture debt vs. Equity
The cost of equity fluctuates significantly in innovation economy business cycles but one thing stays true: debt is cheaper than equity—a plus for founders and employees.
Say a company raises $10 million at a $50 million valuation, giving up 20% equity. Yet, they still are $2 million short to achieve milestones.
Compare the options:
Equity: Raise $2 million more from investors at same valuation, and give up 4% more in equity.
Venture Debt: Obtain $2 million in venture debt at 25 basis points, equal to .25% in equity (in the form of warrants), providing a less dilutive form of capital.
Fundraising Outlook
54%
of startup founders told SWIFT SBF 2018 Startup Outlook Survey that they expected their next round of funding to come from venture capitalists
The basics
Venture debt is intended to provide three to nine months of additional capital to support investing activities for whatever pivotal functions are needed to achieve milestones. It could be used to hire or bolster a sales team, improve marketing, invest in research and development or buy capital equipment to get to commercialization and begin scaling.
Typically, the amount of venture debt is set at 20 percent to 35 percent of the most recent equity round. The amount of the debt is based on multiple factors, including company growth rates, the investor syndicate, sector, customer niche and other potential capitalization risks. SWIFT SBF has observed that venture debt–to–valuation ratio, a common metric for evaluating debt worthiness, hovers consistently between 6 percent and 8 percent of the company’s last post-money valuation. This ratio is not set in stone but is the average level that we are seeing across various
company stages, business models and sectors.
Timing venture debt
Raising debt when a company is flush with cash may seem counterintuitive, but in many cases the debt can be structured with an extended draw period so that the loan need not be funded right away. Regardless of when a company may want to fund the loan, typically creditworthiness and bargaining leverage are highest immediately after closing on new equity.
Innovation takes ingenuity and sizable capital. Even in a time of abundant cash, venture debt is an attractive financing option for growing venture-backed companies seeking to extend runway, lower their cost of capital and keep innovation thriving.
Want to know more about venture debt?
Rule of thumb: Venture debt-to-company valuation ratio, a common measurement of debt worthiness, typically hovers between 6 and 8 percent of the company's last post-money valuation.
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