Venture Debt - Explained
What is Venture Debt?
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Table of ContentsWhat is Venture Debt?How does Venture Lending Work? Types of Venture Debt Commercial banks with venture-lending capacitySpecialty finance firms Academic Research on Venture Debt
What is Venture Debt?
Emerging companies often need venture capital to start, grow and maintain their business, this is why they seek funds from venture capitalists (investors). Venture debt is a type of financing that is made available for companies that already have the backing of venture capital firms or emerging companies. Firms that provide equity funding, specialized banks and non - bank lenders can provide venture debt. It is also a form of business loans that cover capital expenses or working capital. This type of financing augments funding from investors or venture capital firms. Emerging companies with insufficient funds to achieve significant growth through venture debt financing.
How does Venture Lending Work?
Startups or emerging companies with insignificant or low cash flow can access venture debt. It is a type of financing that provide additional funding for companies that are backed by venture capitalists or firms. This financing supplement and complement equity financing. It helps startups and emerging companies avoid equity dilution by providing an additional funding. This is a business loan often combined with warrants that serves as compensation for a higher default risk.
Types of Venture Debt
There are three types of venture debt financing, they are :
- Equipment financing: this is a type of venture debt (business loan) that caters for capital expenses such as buying of equipment that are needed in the workplace or business.
- Accounts receivable financing: this venture debt refers to borrowings which are contrary to the accounts receivable item on the balance sheet.
- Growth capital: this is a fund provided as working capital or milestone financing. It aims to stimulate the growth of a startup company. Term loans used for equity round replacements are forms of growth capital.
The provision of venture debt rests on the financing got from venture capital firm. Venture debt providers are grouped into major categories, they are;
Commercial banks with venture-lending capacity
These are specialized commercial banks that provide venture lending or venture debts for startup companies. These companies can also deposit with the commercial banks. The minimum debt offered by these banks is a business loan of $100,000. They do not just offer debts to any company but those backed up by venture capital firms. The amount of venture lending that is offered also depends of the scale and facility sizes of companies. City National Bank, NYSE:CMA (Comerica), Bridge Bank, Wells Fargo, East West Bank (NASDAQ:EWBC), Silicon Valley Bank and Square 1 Bank are all examples of commercial banks that engage in venture lending.
Specialty finance firms
Speciality finance firms are otherwise called ventures debts shops. The following firms are renowned specialty finance firms; Escalate Capital, ATEL Capital, Eastward Capital, Hercules Technology Growth Capital and Espresso Capital. Specialty finance firms operate on a higher terrain when compared to commercial banks, that is, they offer venture debt at a higher scale. These venture debt firms provide higher dollar size and more flexible loan terms as venture lending. Other examples of venture debts shops include; Lighthouse Capital, Horizon Technology Finance, Oxford finance, Triple Point Capital, Runway Growth Capital and others. The rule of thumb presents the size of venture debt financing as or of the equity capital provided do a company by venture capitalists (firms). Despite that venture debt financing covers all venture capital - backed companies, not all of these companies receive venture debt. Since there are many players and providers of venture debt financing, there are several ideologies backing their operations. A recent study however show that all venture debt providers value uniquely branded VCs banking a portfolio company. The amount of venture debt offered also depends on the scale of a company because venture debt lenders expect between 1225% returns on their capital which is achieved through loan interest and equity returns. Loan or debt terms in venture debt financing differ from traditional bank loans in the following ways;
- Interest rate: this is based on the market in which the loan is offered. The interest rate ranges from 1% to 2% to 3% and also between 14% to 20% depending on both the market and the country.
- Repayment: Borrowers are given between 12-48 months as repayment period depending on the philosophies guiding the lending practices of a venture debt provider.
- Collateral: providers often require a lien on the assets of borrowers as collateral.
- Warrant: A range of 5% to 20% of the value of the loan is often requested as warrant by the lender.
- Rights to invest: Lenders occasionally demand rights to invest the borrower's subsequent equity round on the same terms as the current one.
Academic Research on Venture Debt
- Prospect theory and mean-variance analysis, Levy, H., & Levy, M. (2003). Review of Financial Studies, 17(4), 1015-1041.
- Economic implications of using a mean-VaR model for portfolio selection: A comparison with mean-variance analysis, Alexander, G. J., & Baptista, A. M. (2002). Journal of Economic Dynamics and Control, 26(7-8), 1159-1193.
- Is mean-variance analysis applicable to hedge funds?, Fung, W., & Hsieh, D. A. (1999). Economics Letters, 62(1), 53-58.
- A new pruning heuristic based on variance analysis of sensitivity information, Engelbrecht, A. P. (2001). IEEE transactions on Neural Networks, 12(6), 1386-1399.
- Mean variance analysis of the newsvendor model with stockout cost, Wu, J., Li, J., Wang, S., & Cheng, T. C. E. (2009). Omega, 37(3), 724-730.
- Mean variance analysis of a single supplier and retailer supply chain under a returns policy, Choi, T. M., Li, D., & Yan, H. (2008). European Journal of Operational Research, 184(1), 356-376.
- On the utility theoretic foundations of meanvariance analysis, Baron, D. P. (1977). The Journal of Finance, 32(5), 1683-1697.
- Mean variance analysis of supply chains under wholesale pricing and profit sharing schemes, Wei, Y., & Choi, T. M. (2010). European Journal of Operational Research, 204(2), 255-262.
- Variance analysis procedures as motivational devices, Baiman, S., & Demski, J. S. (1980). Management Science, 26(8), 840-848.
- Decreasing risk aversion and mean-variance analysis, Epstein, L. G. (1985). Econometrica: Journal of the Econometric Society, 945-961.
- A mean-variance analysis of United States long-term portfolio foreign investment, Miller, N. C., & Marina v. N. Whitman. (1970). The Quarterly Journal of Economics, 175-196.
- On the Markowitz meanvariance analysis of self-financing portfolios, Bai, Z., Liu, H., & Wong, W. K. (2009). Risk and Decision Analysis, 1(1), 35-42.