When it comes to funding startups and early-stage ventures, entrepreneurs have a range of options to consider. While venture equity has long been the traditional route for raising capital, venture debt has gained popularity as an alternative financing tool.
In this blog, we explain the key differences between venture debt and venture equity and set out what you need to consider so you can make informed decisions about the best way to fund your growth.
Giving away equity in return for investment has been the mainstay of capital raising for decades. Of course, this also means investors have a say in strategic decision-making. However, there are benefits which can accelerate your growth, including:
Access to expertise and networks
Equity investors often bring expertise, mentoring and contacts to the table. They can provide guidance and open doors to potential partnerships and future investors.
Long term capital
Equity financing provides long-term funding without the pressure of immediate repayment. This enables startups to focus on growth and expansion without the burden of debt obligations
Shared risk and returns
Investors have a vested interest in supporting you to drive growth and profitability so they can maximise their return on investment. As a rule of thumb, VCs tend to be more passive, while private equity providers can be more demanding.
Dilution of Ownership
Selling equity means giving up some control over decisions. You must carefully consider the impact of dilution on their ownership stake and control of the company.
Venture debt providers lend money to start-ups and scale-ups, and is most suitable to companies that don’t have positive cashflow or significant assets to give as collateral. Other criteria includes demonstrably strong intellectual property (IP), and typical revenues >£1m. The pros and cons of taking on venture debt include:
Preserving equity ownership
Unlike equity financing, venture debt allows you to retain ownership and control without diluting existing shareholder structure.
Flexible repayment terms
Venture debt typically comes with flexible repayment options, including interest-only periods and bullet payments at the end of the loan term. This provides cash flow relief during early stages when startups may have limited revenue streams.
Complementary to equity financing
Venture debt can be used alongside equity financing to optimize capital structure. It can bridge funding gaps between equity rounds, support working capital needs, fund specific projects, or extend the runway to achieve key milestones.
Collateral and Covenants
Venture debt doesn’t usually require personal guarantees as long as the finance can be asset-secured. These terms mitigate the lender’s risk but can restrict the company’s financial flexibility and impose additional reporting requirements. However, this varies significantly between lenders.
Cost of Capital
While venture debt may have a lower cost of capital compared to equity financing, it comes with interest payments and fees. You should carefully assess the total cost and evaluate the impact on profitability and cash flow.
Debt or equity
Selecting between venture debt and venture equity requires a thoughtful evaluation of various factors:
Growth stage and capital needs
Your business lifecycle stage and what you want the money for should guide your decision. Early-stage startups benefit from equity financing to access expertise and networks, while mature companies with predictable cash flows may find venture debt plays out better.
Risk Appetite and Control
Ask yourself how willing you are to share ownership and decision-making. Venture debt allows for greater control, while equity financing provides access to investors’ expertise but requires sharing ownership.
Financial position and cashflow
Evaluate your company’s financial position, revenue streams, and projected cash flow. If you can comfortably handle debt repayments, venture debt may be an attractive option. If cashflow is uncertain or limited, equity financing can provide more flexibility.
Consider the long-term goals and exit strategy for your business. Equity investors may have expectations for an eventual exit or liquidity event, while venture debt is typically repaid over time without impacting ownership changes.
What to do next
Venture debt and venture equity offer distinct advantages and trade-offs to help you fuel your growth.
It’s worthwhile to talk to M&A advisors, business coaches and other entrepreneurs who have experience of both venture debt and equity.
This will help you zone in on a funding strategy that aligns with your growth plans, objectives, and risk tolerance.
If you still aren’t sure which way to go, we’re here to help. Drop us a message.