Financing Products: Venture Debt - Take 2
In this latest blog, we continue to explore whether venture debt is right for your company?
The relatively low non-dilutive nature of venture debt, though attractive, cannot overshadow its risks as an asset class. Building off our previous blog dated December 16th, 2019 where we discussed the features and advantages of venture debt, this blog provides a quick overview of common risks and disadvantages of this financing instrument.
· Few (but growing) Options - Finding a venture debt lender that specializes in your company’s particular sector, at your company’s stage of growth and at the amount of funding you require, will take time. Hiring an advisor, such as Kaeros Capital, might be beneficial as it allows founders and management to focus on the growth and health of the business rather than the minutia of sourcing new capital. Having an advisor in your corner who knows how to navigate the venture debt landscape will be beneficial in your capital raising efforts.
· Repayment Terms – Once a venture debt facility has been advanced to a company, oftentimes the loans’ repayment starts immediately. Thus, the party who enters a venture debt contract must be prepared to make steady payments to the lender on the loan. Maintaining growth can therefore become tricky as while management is looking to make strategic spending and acquisitions decisions, cash is going out the door to service the debt. Some venture debt lenders will offer principal holidays (i.e. interest only periods) for up to 6 months or longer, to alleviate this concern.
· Short Amortizations – Venture debt loans typically amortize over a relatively short repayment window, of 3 to 5 years. Because venture debt loans rely on the cash flows of a business for repayment, having steady or growing cash flows is imperative to ensure timely repayment. Being able to forecast out future cash flows, over the life of the venture debt facility, with a high level of certainty is important.
· Higher Rates - Venture debt loans are secured at much higher interest rates, typically starting in the mid double-digits. Some lenders also price in a premium, based on some multiple of the original loan advance, that is payable at loan maturity. Therefore, depending on a company’s cost of capital, ROI and profit margins (both current and forecasted), venture debt may be cost prohibitive. As a result, venture debt is often suitable for high growth companies where the benefits handily outweigh the costs.
· Warrants - In addition to higher interest rates, venture debt providers may include warrants with the debt to enhance their overall return on the loan. Warrants give the lender the right to buy stock in the company they have lent to, at a specific price within a specified time frame. The idea here is that lenders will want to ride along in the success of the company, for which they had some part in creating. Founders and owners must therefore consider the level of dilution implied in the conversion of the warrants, in addition to the coupon being paid on the venture debt loan, and any premium payable, in order to calculate the true all-in cost of the loan.
· Financial Reporting – Lender’s will often invest in company’s who can demonstrate strong financial and operational management. In essence, business owners need to know all the triggers, and impediments, in their business with respect to how the company makes money, what it costs the company to acquire a new customer, how much repeat business is anticipated from each customer and over how long, what costs are fixed versus variable, and what level of costs are necessary to grow sales to some forecasted future level, and more. Whether a company is seeking senior, venture debt or venture capital, having a strong financial forecast to track ones performance against various milestones is recommended for companies at all stages of growth.
In recap, with some preparation and consideration of the risks outlined above, we continue to believe venture debt has a place in the capital structure of Canadian businesses.
If this type of financing is something you are considering in order to grow your business, please send us an email to trevor.palmquist@kaeroscapital.com and we’d be happy to explore some options with you.
Cheers, Trevor
Founder & Managing Director
Copyright 2019 Kaeros Capital Advisors Inc.