Exchanging capital for equity isn’t the only way to finance a startup. And for many founders, retaining as much ownership as possible is a pretty attractive prospect.
One way of getting an influx of cash and retaining ownership is via debt — venture debt, more specifically. But what exactly is it? Which startups are best placed to use venture debt, and how can they do so successfully?
We asked these questions and more to our most recent Sifted Talks panel of experts, including: Sonya Iovieno, head of venture and growth at Silicon Valley Bank; Martin Gibson, venture partner at VC firm Accel; and Catherine Birkett, CFO at fintech GoCardless.
1. So what’s venture debt?
Venture debt is debt a startup takes on from a bank or specialised lender to accelerate growth, usually in between funding rounds. For example, a company may still need more capital in order to grow after an initial funding round — to prevent further dilution and extend their runway, they opt for venture debt which gives them the capital they need.
Sounds great — any strings? When startups use venture debt they enter into an agreement with a lender: the lender provides the capital, and the startup is responsible for warranty and interest payments. Often, businesses also enter into a covenant with the lender, which sets the loan agreement’s minimum financial and performance requirements.
Iovieno says venture debt can be used by companies at any stage, but is most suited to high-growth startups backed by external investors. Venture debt is also an especially useful solution for businesses that operate on a loss.
The debt of the company is so different when it comes to venture debt. Usually, if you go to a normal high street bank, they will ask you for things like your EBITDA and your cashflow stats. Here, we're talking about loss-making companies taking on debt – companies that intend to be loss-making, because they're really focusing on top line growth.” — Sonya Iovieno, Silicon Valley Bank
2. When should you consider venture debt?
While venture debt can help startups extend their runway, Iovieno says startups should have around 12 months of cash runway before even considering venture debt. When negotiating the terms of the debt, this makes your position as strong as possible.
Gibson adds when you’re considering venture debt, the type of project is just as important as where you are in terms of funding stages. For example, it’s probably better to finance riskier ventures with equity, because there'll be no debt to pay back should your gamble not pay off.
Ultimately, if you take debt, you're gonna pay it back. So the key question is, do you have good confidence about how you're ultimately going to meet the terms of repayment of that debt, either through customer revenues or further financing rounds?” — Martin Gibson, Accel
3. Venture debt can help you weather storms — like the pandemic
Gibson says during his time working with one of his portfolio companies, they took on venture debt to give them an extra store of cash in a period of restructuring.
The business thought they wouldn’t need to use the cash at all — but then the pandemic hit. With so much uncertainty, Gibson says access to this extra financing helped them grow as it gave them confidence to invest in their product, even during uncertain times.
[Venture debt] gave them confidence to continue to invest in the product. And I think without that confidence it would have been much more difficult for them to seize the opportunity that was created by people being stuck at home and spending more time online.” — Martin Gibson, Accel
4. What if things go wrong?
As with any business decision, things can go wrong. Birkett told the panel what happened when GoCardless took on venture debt and realised they were going to miss their revenue target.
In this situation, a few things can help, but Birkett says having a good relationship with your lender is most important. With ongoing dialogue and open communication, GoCardless was able to reset the arrangement and keep the business going.
We were able to go into a discussion and effectively reset those numbers and covenants and carry on. That happened because we had a really solid relationship with our bank. I can't stress enough that making sure that you feel comfortable with the people that you're dealing with is super, super important.” — Catherine Birkett, GoCardless
5. How long will you be paying off the debt for?
Nothing comes for free, and startups looking to take on venture debt will need a clear path to repayment. Iovieno says that while most venture debt structures are put onto a three or four year timeline for repayments, it’s very unusual for this to run its course. Startups often end up repaying sooner within 18 to 24 months.
Iovieno says it’s important to know what happens if you repay early, as some lenders waive fees.
When you're looking at the terms of a debt facility, do look at what happens if you repay it early. There may be early repayment — so redemption fees on ending the debt early. [If a startup repays early] we’ll waive all fees, on the basis that we're looking for a long term relationship.” — Sonya Iovieno, Silicon Valley Bank
6. Make sure to read the fine print
When rapidly growing startups are considering venture debt to finance a new product or investment, it's tempting to only think about the big picture.
But Birkett says it’s essential to take a fine-toothed comb to the details of your agreement. Certain actions, like trading too much overseas or expanding internationally, can trigger a default on the loan.
Birkett suggests getting a lawyer to thoroughly look through the contract, considering worst-case scenarios and then weighing out the risks.
I think it's massively important that you get those things highlighted to you at the time that you sign up to the facility. Something that would seem like a tiny point, but actually could cause the whole facility to fall down. You'll want to make sure there's nothing in there that's going to trigger a default on the loan that would catch you out.” — Catherine Birkett, GoCardless
You can watch our full Sifted Talk on venture debt here: