By John Bell
Every growing company and especially the startups have to constantly focus on capital formation and access to it to ensure the smooth running of the business. Without enough capital in hand and without an assurance of a steady flow of it, purchase of equipment and other requirements will be stalled. It will affect the productivity as well as the functionality of your workforce and working capital.
- Firstly, as a startup you must secure an adequate amount of capital as too little of it may result in failure of your company
- On the other hand, too much of it may become bloated
In both the cases, you will be unable to grow as you intend to efficiently and successfully.
Cost is a very critical factor for all business, whether it is small or large, established or startup. If this cost is not controlled properly, no matter how qualified an entrepreneur you are and responsible investors you may have, you are sure to fail. You will not be able to enjoy the fruit of success as all your labor will have diluted along the way.
Need for additional funding
It is these concerns that have led the entrepreneurs to look for supplemental forms of financing. Venture debt provides all startups with the required capital at a low cost, and it makes all the sense to avail it.
- Venture debt is an integral part of a startup and an effective toolkit for debt financing. All venture equity-backed companies are able to meet with the lack of cash flow or assets as opposed to any traditional debt financing. It provides greater flexibility.
- It is a complement to equity financing and is generally structured for a three-year term loan or a series of loans. It contains warrants for company stock.
- Typically, this type of debt is a senior debt and is usually secured by a company that requires specific equipment and assets.
Overall, it can be said that a venture debt is a “risk capital” and this form is less costly than equity provided it is structured appropriately.
The genesis of venture debt
The benefits and significance of venture debt are experienced by the emerging growth companies, and they can use it to increase shareholder value as a startup. In spite of such benefits, the growth of venture debt industry is comparatively low and slow. It is due to the lack of knowledge and unfamiliarity of such form of financing by most of the entrepreneurs. Therefore, it is important to know how it came into existence, the value of it to the investor as well as the entrepreneur and most importantly how you can use it.
When you learn the reviews, you will know that in the 1970s and 1980s the modern venture debt industry started to come in existence. The potential for venture investing grew over the years, but it faced a lot of capital constraints. This was and is still experienced by the startups as well as the entire venture industry in spite of its promises. It dramatically affected the limited partner commitments as well to venture funds.
The changing environment
The environment has been changing, and entrepreneurs and investors now sought more for these alternative forms of financing.
- This type of funding helps the high-tech equipment leasing industry
- It helps to satisfy the capital needs for startups
- It will augment equity capital and at the same time will cause a more efficient capital structure.
The more-established companies usually fund their valuable equipment with debt instead of equity, but startup entrepreneurs and investors traditionally sought for such type of debts that will help them to preserve their capital that is already scarce. This, in turn, will lower the overall cost of financing.
The creditworthiness of the borrowers is usually considered while giving out loans and for companies. Such creditworthiness is demonstrated by the company’s profitability for the past three years. Depending on it, the banks and leasing companies will provide half the value of the equipment. This is because the banks and leasing companies usually have a notion that startups are more likely to fail.
This may be helpful but will fulfill only half your purpose. Therefore, you will need additional capital to satisfy with equity and to cover the other half.
There are a few problems faced when the equity investors of the company provided the banks with a guarantee as they in exchange such a guarantee. That means a considerable amount of the capital needs to be set aside to cover the obligations to the leasing companies and banks.
About the benefits
Venture debts provide a lot of benefits for startup entrepreneurs and investors. This can be expressed in a number of ways:
- Such debts make any venture more efficient
- The capital is used to achieve milestones that are critical for the development of the company
- It is an integral part and an essential tool to increase business as well as shareholder’s value
- It also accords value to future rounds of financing
- It helps in value captured at the sale or Initial Public Offering.
The valuation process of startups is done in a stair-step fashion with the incremental capital afforded allowing a progress before the next valuation event. This involves increasing the certainty of reaching given milestones and minimizing the dilution at the same time by acquiring additional capital at the earlier round.
The value of venture debt is further understood clearly by the incremental ownership retained due to raising the debt that is reduced for the early-stage companies with the additional equity raised at the later rounds in order to repay the debt.
Few additional benefits
There are also a few additional benefits of the value of venture debt as it extends to other different areas as well. You can arrange for a venture loan much more quickly than any other traditional debt or equity financings. This will save a lot of time and management efforts allowing you to meet all unforeseen needs such as an acquisition. If you find the right company, then dealings can be closed within a couple of weeks from initial contact to funding.
John Bell has been writing articles on Social Media, skilled business consultant and Financial Advisor for the last few years. In this post, he has written about the benefits of Social Media Marketing, Business, Finance as well as the features related to the same.