Venture debt or venture lending is a type of debt financing provided to venture-backed companies by specialised banks or non-bank lenders to fund working capital

Working capital

Working capital is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. Net working capital is...

 or capital expenses, such as purchasing equipment. Unlike traditional bank lending, venture debt is available to startup

Startup company

A startup company or startup is a company with a limited operating history. These companies, generally newly created, are in a phase of development and research for markets...

s and growth companies that do not have positive cash flows or significant assets to use as collateral. Venture debt providers combine their loans with warrants

Warrant (finance)

In finance, a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date....

, or rights to purchase equity, to compensate for the higher risk of default.

Types of venture debt

Venture debt is typically structured as one of three types:

• Growth capital
  Growth capital
  Growth capital is a type of private equity investment, most often a minority investment, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business.Companies...
  
  : Typically term loans, used as equity round replacements, for M&A activity, milestone financing or working capital.

Equipment financing: loans for the purchase of equipment such as network infrastructure.

• Accounts receivable financing
  Accounts receivable financing
  Invoice discounting is a form of short-term borrowing often used to improve a company's working capital and cash flow position.Invoice discounting allows a business to draw money against its sales invoices before the customer has actually paid...
  
  : borrowings against the accounts receivable item on the balance sheet.
• Equipment financing: loans for the purchase of equipment such as network infrastructure.

The venture lender effectively piggybacks on the due diligence

Due diligence

"Due diligence" is a term used for a number of concepts involving either an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations...

 done by the venture capital firm.

Providers

Venture debt has been available in the US since the early 1980s and is provided by a group of dedicated funds, finance companies, and banks including ATEL Ventures, Bridge Bank, Comerica

Comerica

Comerica Incorporated is a financial services company headquartered in Dallas, Texas, USA. It has retail banking operations in Arizona, California, Florida, Michigan and Texas; and select business operations in several other U.S...

, Eastward Capital Partners, Gold Hill Capital, Hercules Technology Growth Capital, Culver Capital Group, Horizon Technology Finance, Leader Ventures, Lighthouse Capital Partners, Oxford Finance Corporation, MMV Financial, Pinnacle Ventures, RBC Bank

RBC Bank

RBC Bank, formerly Centura Banks, is the United States retail banking division of the Royal Bank of Canada. The headquarters for the bank are located in Raleigh, North Carolina. Banking centers and automated teller machines are located throughout the Southeastern United States...

, Square 1, SVB Financial Group, Velocity Financial Group, Wells Fargo, Wellington Financial, and Western Technology Investment.

In Europe, some of the firms providing venture debt financing include: ETV Capital, Kreos Capital, Noble Venture Finance, BEST Capital.

In Asis, some of the firms providing venture debt financing include: SVB Financial Group and Western Technology Investment.

Financing Terms

Venture debt lenders expect returns of 12–25% on their capital but achieve this through a combination of loan interest and equity returns. The lender is compensated for the higher rate of perceived level of risk on these loans by earning incremental returns from its equity holding in companies that are successful and achieve a trade sale

Trade sale

A trade and or sale is a common way of exit to a trade buyer. This allows the management to withdraw from the business and may open up the prospect of collaboration on a larger projects....

 or IPO.

Equipment financing can be provided to fund 100% of the cost of the capital expenditure. Receivables financing is typically capped at 80–85% of the accounts receivable balance.

Loan terms vary widely, but differ from traditional bank loans in a number of ways:

• Repayment: ranging from 12 months to 48 months. Can be interest-only for a period, followed by interest plus principal, or a balloon payment (with rolled-up interest) at the end of the term.
• Interest rate: varies based on the yield curve
  Yield curve
  In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
  
   prevalent in the market where the debt is being offered. In the US, and Europe, interest for equipment financing as low as prime rate
  Prime rate
  Prime rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case...
  
   (US) or LIBOR (UK) or EURIBOR
  Euribor
  The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro wholesale money market .-Scope:...
  
   (Europe) plus 1% or 2%. For accounts receivable and growth capital financing, prime plus 3%. In India, where interest rates are higher, financing may be offered between 14% and 20%.
• Collateral: venture debt providers usually require a lien
  Lien
  In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
  
  on assets of the borrower like IP or the company itself, except for equipment loans where the capital assets acquired may be used as collateral.
• Warrant coverage: the lender will request warrants over equity in the range of 5% to 20% of the value of the loan. A percentage of the loan's face value can be converted into equity at the per-share price of the last (or concurrent) venture financing round. The warrants are usually exercised when the company is acquired or goes public, yielding an 'equity kicker' return to the lender.
• Rights to invest: On occasion, the lender may also seek to obtain some rights to invest in the borrower’s subsequent equity round on the same terms, conditions and pricing offered to its investors in those rounds.
• Covenants: borrowers face fewer operational restrictions or covenants with venture debt. Accounts receivable loans will typically include some minimum profitability or cash flow covenants.

Further reading

• http://www.westerntech.com/news/WSJ%20Article%2073107.pdf Venture Debt Gives Software Firm Needed Funding with Fewer Strings
• Venture Debt: Device Financing Lifeline or Anchor? 20 April 2008.
• Silicon Valley Bank: Venture Debt –Maximizing Its Value In The Current Environment 14 April 2004.
• Venture debt in Europe IN VIVO Blog Spot, 25 June 2007.
• What do VCs think about venture debt? Ask the VC, 12 July 2007.
• The True Cost of Venture Debt Sarah Tavel, Bessemer Venture Partners, 23 January 2009.
• The Rise of Venture Debt in Europe BVCA and Winston & Strawn, May 2010.