Venture Debt Explained: A Guide for Businesses and Investors
Venture debt has firmly evolved as a strategic funding source for growth stage companies in Australia. Shifting from a once temporary bridge, debt financing (or growth credit) is now seen as an established mainstream funding option.
Over the past year, Australia has seen more education around venture debt and an increasing number of lenders able to offer greater loan sizes and more flexible lending structures, making debt an increasingly attractive funding source for founders and startup executives.
In 2024, according to the State of Australian Funding Report by Cut Through Venture and Folklore Ventures:
- 22% of VCs advised their portfolio companies to investigate venture debt
- 10% of surveyed Pre-Seed / Seed startups reported having taken venture debt
- 20% of surveyed Series A startups reported having taken venture debt
- 31% of surveyed Series B+ startups reported having taken venture debt
The purpose of this guide is to equip you with an understanding of venture debt so you can make an informed call on whether it may be suitable for your business– now or in the future, and to ensure that investors and advisors are well-equipped to engage in conversations with and provide guidance to the companies that they support.
What is venture debt?
Venture debt is a type of funding designed for startups and scale-ups, typically those who have completed a professional funding round. It involves providing capital in the form of a loan, that is paid back with interest over an agreed period.
Unlike traditional bank loans that prioritise a company’s profitability, venture debt firms look at a startup’s revenue history and growth potential.
The main benefit of venture debt is to minimise equity dilution so that founders can benefit more from future upside.
What is the difference between venture debt and equity financing?
Equity financing, or venture capital, involves investors providing funding to companies in exchange for equity ownership in the business. Whereas debt is provided as a loan, paid back with interest over an agreed term.
Debt should be viewed as complimentary to equity financing, where companies can achieve substantial growth whilst minimising overall dilution.
A collaborative approach also enables more balanced risk sharing between venture debt firms and investors.
Types of debt financing
There are different types of debt financing, each with different benefits and considerations depending on the company’s stage and funding requirements.
- Revenue based financing: access to capital in exchange for a % of future revenue.
- Term loan: funding provided as a loan paid back with interest over an agreed period.
- Line of credit: a type of loan that provides a business with an approved borrowing limit. The business can borrow, repay, and borrow again as needed, and it only pays interest on the funds it actually uses.
- R&D finance: a loan that allows companies to borrow based on the money they expect to receive from a future R&D tax incentive.
What are the use cases for venture debt?
There are four main use cases for venture debt:
- Bring forward expansion: debt is used to fund growth initiatives such as business or overseas expansion and product development. When a business has a clear growth plan and can demonstrate the value it will return for the business, venture debt can be a great tool to achieve business milestones without needing to dilute.
- Extend runway: debt can used to provide extra cash to a business to help meet milestones, scale business operations or bridge towards a capital raise. Startups may turn to venture debt to give them more time to negotiate favourable terms with an investor, or to achieve a specific milestone to increase their valuation before an equity round.
- Complement an equity round: businesses may complete a hybrid round made up of debt and equity to access the funding needed, whilst managing their capital table and equity stakes. As a guide, businesses can typically access debt funding of around 20-30% of the amount of equity raised.
- M&A Opportunities: venture debt enables companies to execute on investment opportunities such as acquisitions that they know will return value for the business.
Venture debt terms explained
We have outlined some of the key terms of a venture debt agreement, though this will vary significantly by lender. It is important for startups to make sure you fully understand any terms before signing a venture debt agreement – you should feel confident to discuss or challenge anything you are not sure of with your lender.
- Funding amount: the amount of capital being lent to the business.
- Fees: the cost a business will incur for the loan including the interest rate and any other related fees.
- Term: the length of time that the borrower has to repay the loan.
- Drawdowns: the process of accessing or "drawing down" funds from a pre-approved loan. Some venture debt firms will allow the borrower to take out portions of the total loan amount as needed, rather than receiving the entire loan upfront. This is typically tied to meeting certain milestones. Draw downs often provide flexibility, allowing you to manage cash flow effectively while minimising interest payments, by only borrowing the amount you need at any given time.
- Repayment schedule: agreed terms for repaying the loan including frequency, amount, interest rate, any interest-only periods, amount for each repayment and the maturity date of the loan.
- Security: agreed collateral or assets that provide the lender with security over the loan. Most specialised venture debt providers secure the loan with general business assets and do not require personal guarantees.
- Covenants: specific conditions that a business has to meet throughout the lifetime of the loan, such as reporting or meeting specific financial ratios.
- Warrants: venture debt agreements may include warrants - an agreement that allows the lender to purchase future shares of your business at a predetermined price. Warrants are significantly less dilutive than equity agreements, typically equating to less than 1% of the capital table.
What type of business is venture debt suitable for?
Venture debt is designed for established, high-growth businesses with consistent and growing revenues that can demonstrate strong growth potential. Importantly, businesses do not need to be profitable to access venture debt funding.
It is suitable for technology, B2B SaaS and any other companies with recurring revenue models or that can demonstrate consistent and growing revenues.
Lenders typically look for:
- The amount of revenue generated over the past 12 months and the likelihood that this revenue will continue in the future i.e. recurring revenue potential.
- Revenue growth rates.
- Cash runway i.e. the no. of months a business could continue operations before it runs out of cash, assuming no additional funding is received.
- Previous equity investments and any intention for future rounds.
- Like venture capital investors, debt providers will also look at the nature of the business, growth potential, and profile and experience of the founding team.
Benefits and considerations
Benefits of venture debt:
- Minimise equity and ownership dilution so you can benefit more from future upside.
- Act on growth initiatives that you know will return value to the business as they arise.
- Buy yourself time to negotiate favourable terms in an equity round or to meet specific milestones to help increase your valuation.
Considerations:
- Only borrow what you need, be careful not to over-leverage debt and put a burden on your business for repayment obligations.
- Pay attention to fees. Discuss your agreement with your provider before signing any terms and make sure you understand any additional fees, if present, beyond just interest rates.
- Look at covenants to make sure they are not restrictive on how you intend to use the funds.
- As outlined above, debt is not a viable source for all businesses as you need to be established and generating steady revenue. When looking for funding, it's important to evaluate all your options and determine which method is most appropriate for your business at that specific time.
List of venture debt firms in Australia
This is not a comprehensive list but outlines some of the key venture debt providers in Australia. Each have different facility sizes, terms and may specialise in different types of debt financing.
Venture debt providers and current facility sizes:
- Partners for Growth (growth debt): $1 - $50 million
- OneVentures: $1m - $20 million
- Mighty Partners: $250k - $5 million
- Lighter Capital: up to $4 million
- Tractor Ventures: up to $1 million
- Kashcade: R&D incentive refunds
If your business is not listed and would like to be included here, please email contact@mightypartners.com.au
Summary
Hopefully this guide has equipped you with a good understanding of venture debt and the confidence to consider whether it's an appropriate funding source for your business – now or in the future.
For investors and consultants, hopefully this enables you to provide greater guidance to any portfolio businesses considering debt.
Find out about Mighty Partners venture debt offering and get in touch with our team if you have any questions or are just keen to learn more – no strings attached!
