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The Founders Guide to
Venture Debt
Written By
Sean Lynden
President, Venture Banking
Startups need capital to grow, but giving up too much equity too early can hinder long-term success.
Venture debt may offer a strategic solution for founders looking to fuel growth while minimizing dilution.
Whether you’re launching a new venture or scaling an existing company, understanding how venture debt works may give you the power to create new opportunities without sacrificing precious ownership. This guide outlines the fundamentals of venture debt and explores how it may enhance your growth strategy.
What Is Venture Debt?
Venture debt is a type of loan specifically designed for startups and high-growth companies that may not qualify for traditional bank loans. Unlike conventional loans, venture debt lenders prioritize a company’s growth potential over profitability or physical assets. This makes it a popular financing tool for companies that are scaling quickly but don’t yet have the steady cash flows or hard assets that typical commercial banks require as collateral. Startups also often use it between equity rounds to avoid giving up additional ownership as they chase the next milestone.
Who Qualifies for Venture Debt?
Venture debt suits high-growth companies that recently raised institutional equity, as lenders focus on growth potential and revenue generation. Prime candidates for venture debt financing include businesses that can demonstrate:
- Recent equity investment: Companies that have recently raised venture capital may be more likely to qualify since lenders know they have passed investor due diligence and have cash on hand. Typically, companies in B rounds or later stages are more likely to qualify, although some seed and Series A round companies may also be eligible.
- Product-market fit: Proven demand for a company’s product or service shows it’s positioned for future growth.
- Path to profitability: While startups don’t have to show current profitability, lenders prefer to see that the company has a clear plan to reach profitability or to raise more capital to repay the debt.
- Growth-oriented industries: Venture debt is popular in industries such as SaaS, technology, life sciences and fintech, in which startups grow quickly but may not have significant physical assets to use as collateral
- Predictable cash flow: Lenders prefer companies with stable or recurring revenue for which cash inflow can be projected with some certainty. Startups with erratic or unpredictable cash flow may find it harder to secure venture debt.
Venture Debt vs. Venture Financing
Both venture debt and venture capital provide funding for startups, but the key difference lies in ownership and control. Venture capital, also known as venture financing or equity financing, involves selling part of the company to investors. Venture capital often comes with governance rights, such as investors who want a say in company strategy or who demand rapid growth. On the other hand, venture debt does not require board seats or decision-making authority. However, the debt may include warrants, which allow lenders to purchase a small equity stake, potentially resulting in minor dilution.
Types of Venture Debt
There are several different types of venture debt, each varying in terms of structure, potential risk and repayment terms. These are a few of the most common.
Term Loans
In the venture debt market, term loans are often the simplest option. They provide access to a lump sum up front with a repayment period that typically ranges from two to five years. Some require monthly interest payments with a balloon payment (large lump sum) of the remaining principal at the end of the term. Others spread out principal repayments starting later in the term.
Revolving Lines of Credit
A revolving line of credit functions like a credit card. The startup can borrow up to a predetermined limit, repay what’s borrowed and borrow again as needed. Interest is charged only on the amount borrowed rather than the total available credit. Revolving lines of credit are often used for companies with fast-growing revenue in the form of formula revolver.
Accounts Receivable Financing
Accounts receivable financing is a short-term loan in which a startup borrows money based on its outstanding invoices. The invoices serve as collateral, with lenders advancing 70%-90% of their value. The line of credit is reduced when the customer pays the invoice.
Equipment Financing
Equipment financing is used to buy or lease physical assets, such as machinery, servers, vehicles or office equipment. The equipment itself serves as collateral for the loan. This is typically structured with fixed monthly payments over a set period and the option to purchase the equipment at the end of the lease.
Convertible Debt
Convertible debt is a loan that can convert into equity during a future funding round or upon reaching a milestone. While it’s initially structured as a loan with an interest rate, the principal can convert to equity at a pre-agreed valuation.
When to Leverage Venture Debt
Venture debt is most effective when used strategically to support a startup’s growth. Many companies leverage it between equity rounds to extend their runway and reach key milestones before their next raise. It’s also useful for funding growth initiatives, such as launching new products, acquiring another company, expanding into new markets or hiring essential talent.
Startups on the cusp of profitability can use venture debt to bridge the gap and cover expenses without seeking additional equity funding. The facility can also serve as a cash cushion during uncertain times, providing flexibility to get through delays or downturns.
Launch Your Venture With Banc of California
Whether you’re just launching your startup or scaling an established company, having the right financial partner can make all the difference. Banc of California offers venture banking for early-stage companies as well as venture banking for established companies looking to expand and grow. Connect with our team to discuss your options.
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