Venture Debt Determining When It’S the Right Path for Your Business

INSIGHTS | Legal Affairs

Venture debt Determining when it’s the right path for your business

INTERVIEWED BY SUE OSTROWSKI

or startup companies lacking the Michael E. Fink cash flow or liquid assets to obtain a Attorney traditional bank loan, venture debt Babst Calland Fcould be the answer to help elevate them 412.394.6477 FOLLOW UP: To learn about venture debt or other to the next level. [email protected] financing alternatives, contact attorneys in our “Startups often lack many of the Emerging Technologies Group. characteristics that would give traditional lenders comfort that a regular INSIGHTS Legal Affairs is brought to you by Babst Calland commercial loan would be a good deal for them,” says Michael Fink, attorney the lender may receive a warrant to HOW CAN A BUSINESS DETERMINE at Babst Calland. “Venture debt can be purchase either common equity or the IF VENTURE DEBT IS THE RIGHT an alternative to help bridge the gap to a preferred equity to be issued in the next PATH? company’s next valuation.” fundraising round, typically at a discount. Just because you can go out and get Smart Business spoke with Michael money doesn’t mean you should. There about how taking on venture debt can WHEN SHOULD A COMPANY should be a solid reason for taking on keep a business moving forward without CONSIDER PURSUING VENTURE venture debt or any other investment. decreasing its valuation. DEBT? It’s really dependent on the Venture debt typically isn’t available circumstances of the business. As with WHAT IS VENTURE DEBT, AND HOW until a company has had a priced equity any financing deal, venture debt can IS IT STRUCTURED? fundraising round that includes a get complicated very quickly, and an At its core, venture debt looks similar to valuation for the lender to work from. experienced attorney can help evaluate other commercial debt a company may Once available, companies find venture where a company stands. Additionally, incur; it may be structured as a term loan debt useful for many capital expenditures venture debt can be obtained from a or line of credit, or an option to draw on or operational needs, or possibly even number of sources, and an expert adviser either. The startup generally may choose acquisitions, all without further dilution can help navigate those options. the facility it feels best fits its needs. to the current stockholders. Although the process could be However, because it’s a riskier loan for It’s common for startups to seek out completed quickly in some circumstances lenders, venture debt terms are generally venture debt after an equity round to (generally resulting in less favorable more favorable to the lender than those bridge the gap to the next round. This terms to the company), having a clear of traditional loans. Borrowers can expect could extend the cash runway to a new vision of your cash needs three to six an interest rate higher than the prime equity round and is generally cheaper to months ahead can allow you to secure rate (5 to 15 percent being common), current stockholders than a whole new the most favorable terms and position more lender control rights and expanded equity investment. your company for success. If you have negative covenants, prohibiting, for Finally, venture debt allows companies six months of funding left and you’re not example, making large purchases or to avoid ‘down rounds,’ where a company currently planning another equity round, divesting a line of business without the sells shares at a lower price than in the it may make sense to start investigating lender’s consent. previous round. A down round dilutes your venture debt options now. Venture debt’s availability is based investors, can impact conversion and Venture debt can play a crucial role in primarily on a company’s ability to raise related capitalization calculations, may helping companies grow. To determine future equity rounds, so venture debt violate contracts, and signals to the whether taking it on makes sense for your lenders often require a small equity public that the company may be troubled. business, speak with an expert adviser component in exchange for the higher Venture debt can help by providing a to help you work through the issues and risk the lender is taking on. For example, path to avoid this decreased valuation. come to the best decision. ●