4 questions you should ask before raising venture debt

As a founder or CEO, you may be considering venture debt as a way to access the capital you need to extend your runway during these uncertain times. Venture debt makes particular sense right now given the fact that equity investors are being cautious and less active overall. And, because so many companies are experiencing slower growth, it’s not only harder to raise equity capital, those that do are getting lower valuations than they would have just a few months ago. 

For these and other reasons, venture debt makes a lot of sense. Usually a term loan or line of credit, venture debt is a form of non-dilutive financing that complements equity. While it’s often used to help businesses delay raising equity while they continue to grow so that they can ultimately reach a higher valuation, these days it may very well be the best option for companies in need of capital.

If you’re considering venture debt, here are some questions you should be asking yourself before making your decision:

1. What are the advantages of using venture debt?

First off, venture debt is non-dilutive, which means you can maintain control over your business for longer, and can continue driving its strategic direction. Venture debt also creates greater economic value for your co-founders and other supporters, especially should you eventually decide to sell the business. Finally, venture debt is also extremely flexible. You can combine it with senior debt from a bank to reduce your overall cost of debt capital, draw it down as and when you need, and repay it when you want.

2. What do you need to be aware of if you’re just raising equity?

While the idea of raising a large equity round can be very appealing, using equity alone to grow a business has some important implications. Because it leads to dilution, over time taking more and more equity will result in you losing control over the business. If you have to give up board seats, then you have less autonomy when it comes to decisions like the company’s strategic direction, staffing and compensation, and your product roadmap. It also means founders, CEOs, and other investors stand to see a smaller payout if and when the business is acquired or goes public.

Financing your business with equity also forces a valuation of the business now. If your company is growing quickly or is about to achieve certain key milestones, it’s better to defer a valuation until a later date when the business will likely be worth more. Raising equity also eats up precious time because it’s not a fast or simple process. Even in the best scenario, it will divert key leaders’ attention away from growing the business.

3. What should you look for in a venture debt partner?

While there’s no shortage of lenders that provide venture debt, it’s important to keep in mind that they can operate quite differently. Make sure to do your homework so that you’re selecting the best partner for your business and one that fits with your long-term capital-raising strategy.

You should look for a partner that allows you to draw down capital as required, so that you’re not paying interest on excess capital that you can’t invest effectively. A flexible partner will enable you to increase funding as your business grows and to prepay your loan without penalty. A rigid lender, however, could impede your business’s ability to execute on its strategic plan and affect your ability to raise additional capital in the future. It’s also important to find a lender that has an transparent all-in cost structure so you’re not surprised by various additional fees such as administration, standby fees, and early prepayment fees, and one that doesn’t have excessive or highly restrictive covenants.

4. Are there situations where venture debt doesn’t make sense?

There are certainly some scenarios where venture debt isn’t the best idea for your company. For example, if your business isn’t growing fast or efficiently enough. There’s no sense in borrowing money at 15 percent if your company is only growing at 10 percent. Likewise, if your customer lifetime value is low or your acquisition rates are too high, venture debt probably isn’t right for you.

Any funds that you borrow should be used to create value, so if you haven’t got a clear plan for using the capital, then now’s not the right time for venture debt. The same holds true if your company hasn’t yet figured out its product market fit. If you’re in this situation, it’s too early to consider raising venture debt; equity might be a better solution.

Looking at the whole picture

Venture debt is one of many viable options to consider when raising capital. If you have all the facts, you’ll know exactly whether or not it makes sense for your business and how best to deploy it to help you meet your strategic objectives.