It’s easy to understand why most discussions about the state of venture capital investing paint a pessimistic view. Access to institutional equity dollars is increasingly limited for new entrepreneurs and early stage companies, and an anemic fundraising environment for VC firms is contributing to the long-anticipated “VC shakeout.” We’re also at a cyclical low in reported M&A events and the IPO window isn’t as open as we all would like, stretching out the time to exit.
But it’s not all bad. In fact, now is actually a great time to be a later-stage growth company seeking capital.
If your company is two to five-plus years into its venture investment cycle and generating meaningful revenue with a somewhat clear path to profitability, chances are good you’re getting tons of inbound investment interest from growth equity firms, foreign investors, and strategic partners, as well as inside investors.
Yet many growth-stage companies I talk to mention a mismatch between management expectations on valuation and/or the amount these new equity investors are looking to put to work. Any slug of equity will create ownership dilution, and these investments often require companies to spend aggressively to accelerate growth. Entrepreneurs weaned on capital efficiency—especially through the Great Recession—often prefer to grow at a more managed pace rather than take on significant equity infusions.
Enter Venture Debt
Traditionally used to extend early stage runway or finance hard assets, the last few years have seen venture debt become an increasingly prevalent source of cost-effective growth capital for later-stage, venture-backed companies. Venture debt financing takes the form of a secured term loan, but one that gives companies as much flexibility as equity because there are few to no strings attached (read: covenants) about how a company can use the capital.
Unlike growth equity investors that need to own a specific percent of the cap table or deploy a minimum amount of capital to make their risk/return profiles work, venture debt investors have no such requirements. This creates a natural match between venture debt financing and growth-stage companies in which even a few million dollars of growth capital—be it to ramp sales and marketing, develop complementary business units, create a war chest for opportunistic strategic acquisitions, or expand internationally—can serve as a significant valuation force multiplier.
Venture Debt by the Numbers
Statistics on venture debt are hard to come by, but my colleagues and I found that in 2012 alone, more than 280 companies obtained $2.01 billion in venture debt financing from over 20 non-bank venture debt firms. Include some conservative assumptions about the number of non-bank venture debt transactions that went unannounced, and we estimate that well over 350 companies received non-bank venture debt financing in 2012.
As venture debt has evolved to serve growth-stage companies, the size of venture loans also appears to have increased considerably. For the universe of transactions we’ve analyzed, the average announced venture debt financing in Q4 2012 reached $8.2 million, up from $4.7 million in 2007.