Venture Debt as Growth Capital? You Bet.

5/21/13Follow @joespinelli

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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.

Joe Spinelli is a Director at NXT Capital Venture Finance. He was formerly a partner with the venture debt firm Velocity Financial Group. Follow @joespinelli

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  • srsurfer

    One of the more active venture debt providers is public, so you can see the size and scope of its investments. Check out Hercules Technology Growth Capital (NYSE:HTGC). It operates in four areas; technology, clean tech, life science and lower middle market. Its investments in the life science and the lower middle market sectors especially are significantly larger than the $8M you cite in your article. It also has significant liquidity in its balance sheet.

  • Todd Gardner

    This is a good overview and nice to see the niche getting some good press.

    For borrowers, chose your Venture Debt provider wisely, and stay focused on how “useable” the money is. A three year term loan when you just raised equity does not really provide much useable capital as it might be all amortized out at about the same time you would have used up the equity.

    If you can’t really use much of the capital to invest in your business, the effective cost gets really steep.

    Focus on structure first.