Venture debt and equity: How do these financing options work together?

Venture debt is a flexible term loan that can help start-ups and scale-ups fund their growth.

If this is an option you're considering, you probably have some questions. You might want to know what venture debt involves, whether it's right for you, what lenders look for and more.

In this article, we explore how venture debt is different to equity. We'll unpack some key distinctions between these funding options, as well as how they can complement each other.

Dilutive and non-dilutive funding: What's the difference?

Raising venture capital is an exchange: investors supply the funds you need to grow in exchange for a stake in your business. As a result, there's some dilution in ownership for your founders and current stakeholders.

Venture debt is not as dilutive as equity. However to qualify for venture debt, you’ll need to have existing venture capital support. That means the venture debt is a potential source of funding to complement equity financing that doesn't require you to give up a large share in the business. It works alongside your equity to help you get to your next inflection point.

What type of dilution can you expect with venture debt? Venture debt financing often involves a small warrant. This is an agreement that the lender can buy future shares in your business at a fixed price. It's often used as a trade-off for the flexible nature of the loan.

Warrants typically involve less dilution in ownership than you're likely to see with equity financing. This can be a more capital efficient way of funding operations, cash runway or working capital.

What are the cost of capital differences?

Venture debt will provide your business with cash runway. This runway (or however you choose to use the funds) is generally a less expensive means of financing performance growth than equity alone. This is partly due to the time and resource demands typically involved in an equity raise.

Unlike equity, venture debt is a loan which means it needs to be repaid over a defined period of time. Your loan will also have a clear cost structure, which might include:

• An upfront fee charged by the lender to cover the costs of arranging the loan facility
• Monthly interest on the amount you've borrowed
• A final payment fee, charged when you make your last loan payment

Crucially, these are costs you can forecast and account for. When you're faced with the daily challenge of managing cash flow, predictability is a big plus.

What to consider when thinking about repayments and flexibility

Raising equity often comes with an expectation of a future liquidity event, such as a sale, acquisition, or IPO. This reassures investors that they will have the chance to cash out some or all of their shares in the future.

So while equity financing doesn't require a set repayment schedule, it does have clear terms for investors to exit their position, often explained in the term sheet.

As mentioned above, venture debt is a loan, and does need to be repaid - typically over 36 to 48 months - but there may be potential for flexibility of repayments within this period based on your relationship with your lender. This could be a key factor to consider when choosing a venture debt lender.

Final takeaway: Venture debt can be a powerful companion to equity for growing businesses

Equity is a prerequisite for venture debt. Rather than viewing these funding options as alternatives, it's crucial to see them as complementary tools to fuel your growth.

If you already have venture capital support and plan to raise more equity in the future, venture debt can bolster your funds.

There are distinct differences between equity and venture debt. How they impact ownership of your business and methods of repayment are clear examples that we have already highlighted. But both emphasise growth and, when used together, can help your business innovate and move forward.