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Could venture debt be a better funding tool than venture capital?

On Behalf of | Jun 16, 2023 | Business Formations

If you’re starting a new company, financing is, of course, key to getting it off the ground. However, obtaining financing from a traditional lender is difficult when you have nothing to show them but an idea and your experience and talent.

That’s where venture capital (VC) firms come in. They look for entrepreneurs with promising ideas and a plan to build a profitable company. However, their funding comes with strings. They typically require a share of the company’s eventual profits and a say in major decisions to help ensure that their investment will pay off. If the company ends up going public or being sold, the venture capitalists who got them off the ground can see a big payoff. 

While venture capital is a well-known way of getting needed seed money, another way is something called venture debt. Venture debt is more like a traditional loan provided by banks and other lenders that specialize in funding new and expanding companies.

This can be a risky proposition for the lender. Silicon Valley Bank, which recently collapsed, was known for providing these loans. 

How does venture debt differ from venture capital?

Like venture capital firms, a lender that provides a venture debt loan often has an equity stake in the business via a legal document called a warrant. However, the business that receives the loan must repay it. Typically, they only have to pay interest at first, and then they need to start paying the principal. 

These loans are more often provided to established companies who need funding for growth than to startups. That’s because the owners can show a record of being able to generate revenue. 

There are advantages for business owners of using venture debt instead of venture capital to fund their company. For example:

  • The lender has less of a share in their equity than a VC firm would.
  • There’s less direct involvement in the company (for example, a requirement that they have seat on the board).

A venture debt lender can still provide a business with expertise they’d expect from a VC firm via their own employees or others they know in the specific industry.

Deciding between venture capital and venture debt (assuming that your business has access to both) is a big decision that can affect your long-term profitability. As you make the decision and negotiate the deal, it’s wise to have experienced legal guidance.