At these levels, venture debt can certainly serve as a meaningful infusion of growth capital.
Not only is venture debt for growth-stage companies becoming more prevalent, but the available pools of debt financing continue to expand. In 2012, seven non-bank venture debt firms announced new capital raises totaling more than $1.6 billion in commitments. Given that many venture lenders can recycle capital throughout their fund lives, this suggests that certain venture lenders are sufficiently capitalized to support companies well into the next decade.
Finding the Fit
In my experience, growth-stage businesses that make the best use of venture debt share characteristics similar to the criteria equity investors use in evaluating prospective portfolio companies. This analysis always starts with the trifecta of a passionate management team, innovative technologies, and large markets ripe for disruption. In addition, growth-stage venture investors prefer companies with validated customer bases and sticky business models that can generate high-quality revenue to justify providing flexible, low-cost term loans.
There’s no consensus about when and where venture debt makes the most sense in a company’s capitalization strategy. But generally, most VCs share our view that venture debt can add substantial value to a wide range of growth-stage companies. Blog posts by Fred Wilson and Bruce Booth are good examples.
One common misconception about debt financing is that it’s only for companies that have exhausted their ability to raise all other forms of more “attractive” capital. Sure, raising a lot of equity brings hype and cachet, but there’s not much economic justification for picking equity over debt, particularly if debt can help accomplish the same growth objectives without contributing significant dilution.
We’ve seen a growing number of high profile growth-stage companies use venture debt to complement growth equity or insider rounds, and in fact, there’s a disproportionate use of venture debt by companies with successful exits. Correlation doesn’t imply causation, but our research shows that although venture debt firms invested in less than 8 percent of the venture-backed companies in 2012, over 40 percent of the venture-backed companies that had IPOs in 2012 had used venture debt at some point.
There’s certainly some truth to today’s gloomy predictions, but it doesn’t apply to all venture-backed companies. Many growth-stage companies have built demonstrable value that’s a testament to entrepreneurial persistence. The strong interest in these companies and the substantial capital available to them—including venture debt financing—means growth-stage companies should never feel compelled to shoehorn an ill-fitting equity investment.