Venture Debt

What is Venture Debt?

Venture Debt refers to a kind of debt financing arrangement wherein companies which are in their start-up or early phase, being backed by venture capital, are funded by the banks or financial institutions in order to meet their working capital requirement or to finance their capital expenses. There is a high risk involved in such debts and thus the financers acquire the right to purchase equity shares in the company as a security.

How Does Venture Debt Work?

Types of Venture Debt

Venture Debt

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  1. Equipment Financing: This kind of financing allows a company to finance its equipment that is necessary for conducting its operations.
  2. Accounts Receivables Financing: This financing is provided by the lenders against the accounts receivable, reflecting in the financial statements of the borrower company.
  3. Growth Capital: Such kinds of funds serves as a source for working capital as well as milestone financing. These are known as growth capital since they help an organization in accelerating their growth.

When to Avoid?

Although raising funds through venture debt may sound prudent, but a company should keep itself at bay from such debt in case of the following scenarios.

  • Suppose a company doesn’t have a road map or means for the repayments of the debt. It is because in the event the loan is not repaid on time, the lenders may overtake the assets of the company to make good of its loss.
  • One should avoid this debt in case the amount that is payable in the installments is greater than nearly 20% of the aggregate operating expenses of the company.
  • If the additional conditions that form part of the agreement are too risky to be agreed upon too
  • If the company doesn’t have any source of capital left and the only option is venture debt.

Venture Debt vs. Venture Capital

The key differences between the two are enumerated below.

  • The major difference between venture capital and venture debt is that this debt needs to repay.
  • In the case of the venture, capital control is diluted, which is not the case in venture debt since no equity stocks are issued.
  • The conditions are harsher in venture debt, and the consequences can be serious when conditions are not met.
  • It is cheaper as compared to venture capital.

Advantages

  • It is an easy way for start-up companies to raise funds by way of debt once they have raised venture capital.
  • The companies are able to get funding without diluting their control by way of issue of equity shares.
  • It is a way much cheaper way to raise funds as compared to equity.
  • It helps the companies to meet their growth objectives.

Disadvantages

Conclusion

After a round of equity has been closed recently, going for a venture debt will be easier for the companies since creditworthiness will be highest at such time. The companies should make sure that they have sound business plans, which should ensure that repayments of such loans can be made at the time. These funds can help companies accelerate their growth and performance.

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