June 28, 2022
As a private credit marketplace that helps non-bank lenders secure asset-based loans, we have seen a notable uptick from borrowers seeking to connect with institutional investors for venture debt financing to grow their businesses.
Startups and other companies leverage venture debt, specifically revenue-based financing, to fund growth activities that will have a direct impact on driving sales, such as marketing, advertising, R&D and attracting new talent. For many fintechs, revenue-based financing is an efficient way to raise growth capital, particularly when the business has strong top-line revenue.
From our vantage point, there are multiple reasons for the rise in venture debt as a growing form of corporate financing.
As the number of VC-backed companies has grown, so too has interest in venture debt. The whole startup ecosystem has developed and deepened in a virtuous cycle that is supercharging early to mid-stage companies and prompting them to seek even more capital. The number of VC-backed companies has increased significantly in the last 5-10 years, and as these companies look to fill additional capital needs, many, particularly those with strong revenue numbers, are eyeing venture debt. A key reason? Debt financing helps principals and shareholders avoid dilution of their ownership stakes, while raising necessary capital for business growth.
Demand is strong - low rates are pushing investors into higher-yield asset classes. In the absence of attractive public fixed-income opportunities, investors are hunting for credit market returns in other, more alternative asset classes. Many are attracted to venture debt because of its risk profile. The loans are short-duration – typically 2 years or less – giving the investor clear visibility into the borrower’s likely revenues. Lenders are senior in the capital structure; VC equity investors are subordinate, which encourages the borrower’s VCs to support the management team in maintaining and growing revenue.
Revenue-based loans create more opportunities for company growth and investor return. The key metric for borrowers is annual recurring revenue (ARR). With revenue-based loans, borrowers aren’t restricted by prior valuations or other factors, such as who their venture capital provider is. Deals are structured with floating rate coupons, negating any interest rate risk. As borrowers use revenue-based loans to invest in activities such as digital advertising that will stimulate and grow sales numbers, the lender takes a portion of the revenue until the loan is paid off.
Investor considerations. In addition to looking for robust ARR, investors also want to see a strong management team with a solid growth strategy, a supportive customer base, a business plan that generates free cash flow on a sustainable basis and a low leverage profile in the capital structure. Borrowers accept covenants demonstrating, for instance, minimum recurring revenue growth, evidence of current free cash flow and limits on activities that could potentially diminish the company’s value, such as asset sales.
Venture debt has expanded access to capital to many companies that previously would not have been able to secure private credit due to their size or valuation. In the past 12 months, many fintech lenders have come to Finitive seeking both asset-backed debt and venture debt, to receive funding for both their lending initiatives (through asset-backed debt) and their company operations (through corporate and/or venture debt).
As new funding sources for growing companies continue to develop, investors and borrowers alike are benefitting from more innovative capital-raising structures. Liquidity begets liquidity. It will be interesting to see how new venture debt deals continue to boost companies’ business operations and revenue streams around the world.
All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid, speculative and are not suitable for all investors. Investments can lose their entire value. Securities on the Finitive technology platform are offered through North Capital Private Securities Corporation, member FINRA/SIPC.