Venture debt is a source of financing for most entrepreneurs. It is a type of financing offered to startup businesses to enable them to run the business. Many firms use the capital for equipment financing or even growth capital. Venture debt allows the firm to request extra funds without the same dilution level as pure equity. Companies can use it to increase sales through marketing. This form of financing can provide valuable options for early-stage businesses. The money lenders choose investments through the underwriting process. Some of the factors that need to be considered during the underwriting process include market condition, management team, and even the product. The repayment source for this form of financing is generally through future equity rounds. The lenders should assess whether the firm has capable of raising the future matches.
The venture lender makes money through fees, warrants, and even interest repayments. The venture lending is more focused on enhancing relationships with the entrepreneurs. The company can use venture lending to develop new products and staff training.
Here is an overview of the types of venture debts
- Term debt
The term debt is a type of loan which has to be repaid after several years. It also entails fixed interest rate payments. Venture lending, in this case, can be forecasted for the borrowers.
- Royalty monetization
The royalty monetization is centered on the firm’s forecasted income stream. The firm gets the money based on future revenue. When the borrower’s income performance changes, the loan payments also change relative to the determined multiple of the initial
loan. The venture lenders get their money back through royalties which is the percentage of the firm’s revenue. Royalty financing is mainly used in companies with significant revenue streams as they can repay the loan and even pay for the forms expenses compared to the small businesses.
- Equipment financing
The equipment financing is used in the provision of costly capital goods. The repayment period is in alignment with the equipment’s life span. The equipment financing is not of great value for some assets, such as the asset–free SaaS (Software as a Service). The lender can request a lien on the equipment as security for the loan. Once the loan is fully repaid, the firm owns the equipment free of any lien. The equipment financing rates depends typically based on the prevailing market conditions. Equipment financing can also help the firm build business credit. However, this form of venture lending can damage the firm’s credit score if it fails to make the payments. One can get a loan from online lenders or even a commercial bank.
- Line of credit
The credit line helps fund a firm’s investment in the current assets. The short-term assets may include accounts receivable and even equipment. The capital is enough to cater to the daily operations associated with payroll and overheads, which is essential in the early growth stage of the business as it can borrow until it hits the credit limit. One of the limitations of this form of venture lending is that most lenders require a minimum of 6 months in the business industry. It may be a challenge for startup businesses to obtain this form of capital.
To sum up, there are numerous types of venture debt. The above article illustrates some of the classes an entrepreneur can choose.