Venture Debt vs Venture Capital, which is better?
Are you ready to bring your startup to the next level? Are you thinking of raising from Venture Capitals (VCs) or Venture Debts (VDs)?
We can all agree that money is one of the most significant factors in a SME’s success. In fact, according to an article written by Forbes, one of the most common reasons behind why businesses fail is the lack of capital or funding. Today, SMEs have more financing alternatives than the traditional equity financing from venture capitals.
Equity financing involves selling a portion of the startup in return for capital. For example, when Firm A wants to raise capital for its operations and expansion overseas, the owner decides to sell its 15% ownership to a group of investors in return for capital. The investor now owns 15% of the company whereas the owner owns 85%. Although the owner has no obligation to repay the investor, there are downsides to this. In future equity financing rounds, the owner would have to give up more of its company and share profits with its investors.
Venture Debt Financing
Venture debt financing can be an alternative or complement to equity financing as it prevents dilution of the owners and its existing investors equity stake. Besides, collateral is not required as startups have yet achieved positive cash flows to obtain conventional loans from traditional financial institutions. Instead, lenders are sometimes compensated with the company’s warrants.
Venture Debt as a Complement to Equity Financing
Let us take a deeper dive into venture debt as a complement to equity financing.
Typically, startups take on venture debt after an equity raise. This increases the total amount raised without diluting more equity owned by entrepreneurs and investors. Besides, this extends the cash runway of startups which promotes confidence in its stakeholders. With so much uncertainty surrounding us it also acts as a buffer for what can go wrong, for instance, cancelled contracts and projects from clients.
However, many early-stage startups rarely consider debt financing as a funding source because of the following misconceptions:
- Debt funding for startups is too expensive
- Debt funding from venture debt lenders should be last resort
- Early-stage startups are unable to obtain startup loans due to poor cash flow and poor business credit score
- Debt funding for startups is bad for profit
Some also think venture debt is synonymous with convertible debt/ convertible notes. The latter can be converted into equity, but such rights are not attached to a venture debt. This is optimum for founders that want to avoid painful dilution. Debt has been hard wired in us as a ‘bad thing’ but think about the possibilities you can unravel. A short-term debt facility could allow you to fuel your startup’s growth with little equity dilution; or increase your cash runway to achieve the next milestone.
Whether you want to take on venture debt or venture capital, there are many flexible options out there. Here at Lyte Finance, we provide customizable debt structures for your startup. Speak to us by reaching out at [email protected]