When businesses start, they need many things. These include new employees, plans to execute their ideas, partners to help manage different areas, etc. However, funding is one of the most vital things a new firm needs to give wings to its ideas. A common problem these new firms face is the lack of resources to get all the funding they need. That is exactly where venture debts come into play.
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What Are Venture Debts?
Venture debt is a type of loan financing firms receive from banks and non–bank lenders, especially for startup companies to raise their capital. Also, it is less expensive than other financing methods. Moreover, it offers loans to early-stage startups with good transaction history. In this way, companies use this in addition to venture capital.
How Do They Work?
Venture debts are different from other loans. It is because the period of loan has short to medium-term goals. Hence, the repayment period is up to 3 or 4 years. Loan recipients can either repay the full amount at the end of the loan period or go with organized payments. It merely depends on how the repayments fit with an individual’s goal.
Venture debt providers have different procedures for evaluating how much a company can borrow from them. They mainly depend on the amount raised during the previous round. Hence, equity financing is still vital for firms aiming to obtain venture debts. So, they have to describe how they performed during the previous round of raising funds. Further, they have to justify the amount they ask for and reveal the plans to go for another round. In addition to this, they have to explain exactly how the loan will help them grow their firm.
Usually, the debt is about 30% of the initial amount raised during the previous round. However, the amount varies depending upon the type and scale of the business. It can even go up to 50% of the initial amount. But, venture debts are a high risk for the investor. Even though the firm may have proof of concept and sales, they may not always know how scalable the business is. Thus, the lenders ask for something called warrants.
The lenders can then convert these warrants to equity. However, the price of these shares would be the price of the shares at the last round of raising funds. In addition to this, lenders may also ask for covenants. They do this to ensure that the company repays the amount. Usually, individual lenders are flexible about this. However, banks ask for it.
How Are They Helpful To Startups?
StartupsDepending on the industry, startups generally face problems regarding inventories, manpower, etc. However, venture debt is a good way to solve these problems. It is because it offers money without any collateral. It is quite attractive to startups as they may not have the necessary resources to show as collateral. To choose the best investment option, the venture loan lenders look over the following:
- Product description
- The team management
- The marketability
Thus venture debts are great ways to finance the needs of a business during its early days. It can help the firm grow to its highest potential. However, it can be risky for investors and does not replace equity.