Venture debt is a valuable tool that founders can use to grow their companies, and with more flexibility in repayment terms than traditional lenders, founders shouldn’t shy away just because it’s debt.
Mainly used in conjunction with equity financing, venture debt enables founders to extend their runway and grow their company without losing equity. In embracing venture debt, lending is part of the flywheel we leverage at Golden Section to empower revenue generation through marketing and sales growth.
Understanding Venture Debt
Our focus is on companies that have a track record of ARR growth and an effective marketing and sales team; those kinds of companies can leverage debt to rapidly expand their growth efforts. While there are standard use cases for traditional venture debt, our approach is based on ARR, as our funds are specifically targeted at ramping up a company’s ARR.
Traditionally, venture debt is a collective term for minimally dilutive loans used to finance high-growth, venture-backed companies. Golden Section offers venture lending as both an alternative and a complement to equity financing; we focus on revenue and sales efficiency, utilizing these metrics to determine viability for debt, not just equity financing.
The main advantage venture debt has over equity financing is that a founder gets the funds they need to grow their company, while retaining control of their equity. Each round of capital raised in return for equity, dilutes the founder’s ownership, impacting their results during an exit. This ends up leading many founders to seek ever higher valuations and more capital, instead of focusing on what really matters to a SaaS company, revenue. Chasing capital means chasing unrealistic growth to validate higher valuations and can lead founders down a path of less equity on an exit.
IF a founder is just chasing the next round they are not right for our portfolio. We don’t believe in chasing the next round, instead we believe in using capital efficiently to achieve a revenue growth flywheel and know that venture debt aligns well with this strategy.
So, a founder may have to consider what’s more important to them in their journey: being debt-free or retaining equity?
We know this isn’t an easy decision, but fortunately, there are several guidelines that can help in making the best decision for a founder.
Common Scenarios in Which Raising Venture Debt Is the Right Move:
- You’ve recently raised an equity round and want to extend your runway without taking on additional dilution
- You’re in the process of raising an equity round and want to limit your overall dilution by supplementing a portion of the planned equity raise with debt
- You need additional funding to capitalize and expand upon a high performing marketing and sales team
Venture Debt vs. Venture Capital
Both venture debt and venture capital are used for the same purpose: to accelerate a startup’s growth. However, the way they go about this is very different.
Venture capital is a form of equity financing, which means a founder needs to sell a sizeable portion of their company’s equity in exchange for funding. Venture debt means taking out a loan and involves repaying that loan, regardless of performance. This significant difference is presented in the following ways:
- With Venture Capital, the equity dilution occurs at closing of the raise and typically ranges between 15% to 20% of the company, whereas with Venture Debt the dilution is typically in the form of a warrant amounting to 1% to 5% of the company.
- Venture Capital investors require board seats, resulting in less control of the company for the founder; Venture Debt lenders rarely require board seats with their funding.
- The cost of capital with Venture Capital is a function of the company’s valuation at an exit, which can (and has) amounted to a cost of over 100% per annum, while the cost of Venture Debt is set by a predetermined interest rate at closing, typically in the low to high teens.
- Venture Capital investors anticipate recouping their investment upon a large liquidity event, such as a sale or IPO of the company, and therefore do not require regular repayment of their funding, whereas Venture Debt is a loan with a contractual repayment term, typically monthly.
- Venture Capital investors seek to invest early in companies with the potential for rapid growth and assume a large amount of risk with their investment. Venture Debt lenders look to fund companies with a track record of growth and assume a lower amount of risk with their funding.
Is There Any Time When Venture Debt Is Not a Good Option?
Yes, it is important to understand where a founder is in their startup’s journey and whether venture debt is appropriate. Situations in which venture debt isn’t a good option include:
- When immediate capital is needed, the best time to obtain venture debt (whether funded or committed) is when a company is not in immediate need of it.
- If the business is struggling and there is concern the company may not be able to repay the debt.
- If the lender is requiring performance or financial-based covenants that the company is not ready to meet within a relatively short period.
- If a company is pre-revenue, most venture debt lenders rely on revenue as their form of repayment
Navigating Growth Together
The decision to raise venture debt isn’t one to be taken lightly. As a partner that has gone through working with startups of all stages of building B2B software companies, that has helped countless others determine the right path for them, we are confident that we can help founders make the right choice regarding venture debt.