VENTURE DEBT MARKET IS GROWING FAST
Striking the right balance between debt and equity to optimize growth
A lot of startups are unaware of their financing options early on, and often make decisions ‘in the now’ rather than plan ahead, which at times can prevent their original vision from fully being realized.
In the heavily VC-funded Israeli start-up ecosystem entrepreneurs are often in a race to raise numerous equity rounds every 2-3 years, equity dilution may seem to be the best route for realizing ambitious ideas, and sometimes it really is. But the picture is a bit more complex than that, and entrepreneurs should understand they have another option -- one that may be better suited for their goals, and which can serve them as a cheaper source of financing in the long run.
Startups should keep in mind and anticipate the long journey that lays ahead. The more the company grows, the more there is a need for a scalable source of financing as well as a debt strategy. Startups that generate a hearty amount of revenue and cash flow, and are confident in their future equity fundraising, should consider venture debt as a solution.
We’ve set out to highlight both types of financing equity and debt, so you can make a more informed decision when the time is right.
Raising equity means you are giving a piece of ownership in your company in exchange for funds to get you up and running while you’re either pre-revenue or your monthly burn rate is rising to scale.
Options for raising equity include accelerators, angel investors, venture capital, private equity, corporate venture capital, family offices, and other non-traditional forms of equity-based financing.
It’s important to note that venture capitals and investors generally expect a 3-5X return on their investment within five years. If your projected growth rate is different, you might want to consider additional forms of financing.
To some extent or another, we’re all familiar with debt. At some point we’ve all probably at least had a student loan, had a credit card, or an auto loan or lease. Debt means you are borrowing.
When it comes to your startup, the most obvious advantage of using venture debt is less dilution and added flexibility with spending. Your business is in your control. Your holdings stay intact. Founders get to make the decisions, as well as keep the profits.
Venture debt market is growing fast
Many entrepreneurs recoil at the word debt, but for VC-backed companies that already have initial revenues, the upside can far outweigh the risk. Typically, you can use venture debt to increase liquidity or extend burn, or to finance certain assets. According to Pitchbook in the US venture debt is growing faster than the broader VC market.
Banks offering venture debt do take business collateral, but once they provide the backing, they’re usually in it for the long run, and even in the case the business encounters a rough patch, they will be there to offer the best solutions to get you back on track.
Reaching a Value Milestone
For startups, there are certain financial milestones, for instance $5 million in annual recurring revenue, that open up a variety of new investors and exit opportunities. Venture debt has the potential to extend the runway enabling startups to reach a key value milestone before raising that next round.
More so, startups when raising an equity round take on a layer of debt in parallel, to ensure their equity becomes more efficient.
This is highly beneficial for entrepreneurs seeking to grow faster without having to dilute their holdings at every round. As a rule of thumb, equity raised with a layer of debt, opens up more options for a higher valuation at the exit / IPO.
Tech companies whether with term-subscriptions, revenue recognition, and SaaS metrics should add a potential debt strategy to their plans.
It’s also important to keep in mind that you can adopt a hybrid approach to financing, leveraging both equity funding and debt financing.
Discount Tech is firmly rooted in the VC world, and we understand the power of equity but also understand how to support entrepreneurs long term mission with debt financing, striking just the right balance between the two.