What do venture debt providers look for?

Venture debt is a potential source of funding for early-stage, fast-growing businesses that have secured equity investment.

Given venture debt facilities’ unique nature, providers of these loans have specific requirements and criteria they take into account before lending. With that in mind, it's useful to know what lenders look for if you're considering venture debt as an option for your business.

In this article, we focus on common questions you might receive from venture debt providers and how you can prepare for them.

Are you likely to raise additional equity?

Equity and venture debt are different but complementary. Equity investment is available to high-growth businesses that can meet investor criteria, and having this venture capital support already in place is a prerequisite for venture debt.

Lenders will generally be more interested in growth than current cash flow, working assets or profitability. They will see equity backing as validation of your growth potential.

Venture debt providers will also view access to equity capital as the primary source of repayment (PSOR) for your loan. That means they will likely want to know your plans for raising additional equity.

This could lead onto the next question, regarding potential factors in your next business valuation.

What are your equity round valuation metrics?

Since venture capital is the most common PSOR for a venture debt loan, lenders will think carefully about future equity round valuations.

As you prepare to negotiate with providers, consider the metrics that might impact the valuation.

Debt-to-equity ratio, for example, could be important. It shows investors how much you rely on debt to fund your operations.

Free cash flow can also reflect the financial health of your business. This reveals how much cash you have left over after operating expenses and capital expenditures.

These metrics are likely to be viewed alongside broader indicators such as past performance, growth prospects and market conditions.

What is your path to non-dilutive investment?

Ownership dilution occurs when owners exchange a percentage of control over their business for funding. It's a common consideration for start-ups and scale-ups looking to raise capital.

Equity investors provide vital funding and support for growth, but handing over a stake in your company typically reduces control for founders and directors.

Strong business performance can improve your chances of securing non-dilutive investment in your next equity round.

This is something venture debt providers will want to know. Be prepared for questions about your liquidity and progress towards key milestones ahead of your next financing. If these signals are positive, you'll be in a better position to attract non-dilutive term sheets from investors.

How is your burn rate?

Burn rate is a measure of how quickly you're spending your cash reserves. It's a key metric for start-up founders to understand and keep track of.

Managing your burn rate can help you fuel growth through strategic spending between investment rounds, without losing control of costs.

Venture debt providers will look at burn rate relative to revenue growth when assessing your runway – particularly the number of months left until you run out of capital.

Final takeaway: Preparation is key

Preparing data on burn rate, liquidity, progress towards milestones and equity round figures will help you answer venture debt providers' questions.

But don't forget that the relationship is a two-way street. Preparation and research will also help you find the right lender to meet your needs.