If you’re looking to raise capital, you probably know that it’s a lot harder to get an equity term sheet these days than it was just a few months ago. Admittedly, if your business hasn’t contracted because of the pandemic or has actually gotten stronger because of it, that’s not the case. But when I look across the dozens of discussions I’ve had with investors over the past few months, it’s pretty clear that financing activity is down overall and that investors are being more cautious.
The underlying issue, of course, is that the global pandemic has led to a great deal of uncertainty, making it much more difficult for most businesses to accurately forecast growth. As a result, many investors have become more conservative about when and where they deploy capital. And, in those cases where they do issue a term sheet, they often contain a variety of additional protective provisions to help investors mitigate their risk.
Coming to terms with the new reality
Not only have equity investors been issuing fewer term sheets than normal, the ones that are issued often include lower proposed valuations and smaller check sizes. Practically speaking, that means that instead of giving companies 18 to 24 months of operating runway, these days they’re often offering much shorter runways. Plus, to help protect their downside, they’re requesting greater transparency through increased reporting and governance rights.
To be fair, lenders aren’t immune to these same challenges. Similar to equity investors, they’re having to apply increased scrutiny to company forecasts given the current economic uncertainty. As a result, some debt proposals may have tightened as well in terms of the amount of leverage or pricing being offered.
Daunting as all of that may sound, there’s still some good news.
Why debt is more attractive than ever
While equity term sheets are harder to come by and often contain more protective provisions than was the case just a few months ago, the reality is that venture debt is more attractive than ever before. That’s because, unlike a priced equity raise, venture debt doesn’t force a valuation of your business right now, when it may not be performing as well as it otherwise would. That means that you can get the capital you need without having to give up valuable equity to do so. Not only will that put you in a position to extend your runway so that you can delay raising equity until you can get a more favorable valuation, it also means that you won’t have to suffer additional dilution in the process.
At a time when securing a favorable equity term sheet is more difficult, now is the time to consider venture debt. It’s a far more attractive option than giving up more equity to raise capital than you’d otherwise have to. That’s because, in the long run, raising equity on unfavorable terms is much more punitive than the cost of debt financing. Not only that, venture debt deals typically close much faster and can be done remotely, both critical factors in the current environment.
The bottom line is that if you need financing, you should be giving venture debt a very close look.