Venture debt is a lending product offered by Elkstone through the Alternatives business vertical. This refers to loans provided to early stage companies that are often not cashflow positive and lack the collateral to qualify for a traditional bank loan. While venture debt has its origins in the 1970s with equipment leasing to early stage American semiconductor manufacturers, it has recently seen a surge with notable new products and market entries in the Q1 2020. Underpinning this growth are asset light, early stage companies finding debt an attractive supplement to equity raises.
Pádraig Owens is a Director of the Alternatives team at Elkstone.
Below are a number of scenarios where an early stage company might require venture debt, creating opportunities for our clients.
- Extend Runway to Cashflow Positive An early stage company may have a reasonably good view as to when it will reach break-even. However, the company may not have the cash reserves to survive until this date. In cases such as these, venture debt can be a helpful tool to extend cash runways while the borrower is trading its way to and, eventually, past breaking even.
- Bridge Working Capital Requirements Ahead of Equity Raise Equity raises can distract a company from its core activities. Considerations as to the company’s valuation, which investors get what terms and who is brought into the company can steal a significant amount of focus. Raising loan capital is considerably less complex and can smooth a cashflow negative company over to the next equity raise, often making these fewer and farther between.
- Valuation Booster Founders, naturally, want the highest possible valuation for their company. Not only does this allow them to give away a proportionally smaller part of the company for the same amount of cash in an equity raise, it also makes for the most lucrative exit events. Venture debt can help achieve these goals either through introducing leverage to the business or through allowing the borrower additional time to reach certain milestones that increase its valuation.
The Case for Venture Debt
The interest rate payable to investors is commensurate with the risk taken and is often in low double-digit territory. The Alternatives team at Elkstone seeks to protect investors as much as possible, and structure loans with strong covenants and a strong support in the form of shareholders. Borrowers are typically backed by high quality venture capital firms, providing significant comfort for venture debt investors.
Furthermore, we seek to structure loans to create the potential for upside yield under specific circumstances. Examples of how we have structured potential for upside yield include success-based bonuses in the event of a liquidity event or a successful drug licence application.
In line with our founder friendly philosophy at Elkstone, we also carefully consider whether venture debt is the right choice for a prospective borrower.
Alternative lenders are experiencing increased demand as traditional avenues of funding have dried up in the context of the COVID-19 liquidity. Read the full article here.