WHAT IS VENTURE DEBT?
A start-up or an early growth stage company typically receives several rounds of equity investment from its investors with each round providing sufficient capital to achieve predefined milestones. Upon reaching its milestones, a company will need to raise a subsequent round of financing to finance further growth. Providing some debt financing between equity rounds (“Venture Debt”) helps companies and investors ‘extend the cash runway’ of their investments. By using debt, the company is able to access capital without giving up as much equity. The debt can be used to finance the company’s growth and capital expenditure requirements enabling capital ‘equity’ to be reserved for funding business critical activities such as accelerating product development or making key hires.
Additionally, by providing companies with a flexible cushion of capital, venture loans serve to stretch the amount of time between equity rounds and help entrepreneurs reach the next valuation milestone in their company’s life cycle. Put differently, venture debt enables the entrepreneur to run the company for a longer period of time, increasing the enterprise value of the company, before raising more equity money.
HOW VENTURE DEBT DIFFERS FROM TRADITIONAL BANK LOANS?
Traditional bank loans are rarely available to start-ups or young companies. When available, bank loans are either insignificant in size, involve severe limitations on the use of funds, or are painfully over-collateralized with promoter guarantees and personal pledges. Dealing with traditional lenders that don’t understand the model of lending to early stage companies can detract management attention from focusing on the operational aspects of building their businesses.
Pyramid on the other hand, has been dealing with early stage companies for almost 20 years. Our venture debt financing is structured specifically to support start-up and early stage entrepreneurial companies with greater flexibility in loan amounts and structures as well as a more reasoned approach to the manner in which loans are secured and monitored.
In addition, Pyramid is generally recognized by both clients and investors as a ‘patient lender’. The philosophy has always been to build on the trust and relationships with clients and work through tough situations, especially in deals involving early stage companies where there is a greater need for flexibility as lenders.
WHEN SHOULD A COMPANY RAISE VENTURE DEBT?
The best time to raise venture debt is in conjunction with or immediately after raising a round of equity, i.e. when there is the most capital in the company. It can be done at other times, but often with less favourable terms. Venture lending is appropriate at the following times:
• As part of a funding round where, for example, rather than raise $7.5 million in a funding round, a company can raise $5 million in equity and $2.5 million via venture debt
• To extend cash runway when a company knows that it will need to raise another funding round in 12 months, but would like to extend that timeframe to 18-24 months
• As working capital in a situation where even though a company has sufficient operating cash, it needs cash for working capital and can extend its resources via a debt facility
• To finance purchase of equipment or finance office expansions and build outs, for which equity would be a more expensive alternative
WHAT ARE THE BENEFITS OF VENTURE LENDING?
• Extends the “cash flow runway” for the company and makes it easier to achieve the next valuation milestone
• Venture lending represents a less dilutive type of financing than equity financing since venture lenders generally require less of an ownership position.