Silicon Valley Bank’s nosedive has soured many on venture debt, and for early-stage companies, it bears being cautious. As an option for growth-stage companies with more predictable cash flow, however, things may be a little different. TechCrunch+ spoke with David Spreng, founder and CEO of Runway Growth Capital and author of “All Money Is Not Created Equal” to help to clear up some of the misconceptions that surround debt.
Even though the interest on venture debt is usually astronomical, venture debt’s main advantage is that it doesn’t require startups to give up any equity. Not diluting shares in order to raise money can have a huge impact on the economic outcomes, and raising money through a bank loan is usually much easier than raising a round of venture capital.
Though taking on debt isn’t always the best option, there are some circumstances you may find yourself in where it makes the most sense.
Venture debt is a way of borrowing money, usually between $1 million and $100 million, without any tangible assets to secure it. This is where it differs from a business loan. You might be able to get yourself an unsecured business loan early on in your company’s life, but it’ll be for a relatively small sum of money and the interest rates on it will be on the high side. In some cases, founders have to supply a personal guarantee when they take one out. A secured loan, on the other hand, takes tangible assets as collateral. Startups might not have a whole lot by the way of tangible assets, but they could have other valuable assets. This is where venture debt comes in.
Venture debt is borrowing that’s secured against your intangible assets: predictable future revenue, your IP, and your future VC backing, for example. There are effectively two types of venture debt: early stage and late stage. Early-stage debt tends to be offered on the basis of a startup’s VC backers. Spreng’s own shop, Runway, on the other hand, provides only late-stage debt. It’s for companies that are on the verge of profitability but need an injection of funds to help them obtain the growth they need in order to reach it.
“We position ourselves as being the latest stage, least risky provider of this type of capital,” Spreng said. “So a lot of the companies are very much on a path to profitability, or even a path to exit. We look for a real business that has real products, that isn’t going to go out of business and isn’t contingent on whichever VC happens to be behind it.”
That line about it being financing for a company that isn’t about to go out of business? That’s critical. For a lot of VCs, debt is synonymous with rescue capital; that’s a significantly different business model than later-stage venture debt. Using borrowed money to try to lever up a failing company isn’t good for anyone.
And there are other reasons that venture debt is a better choice than venture capital for some late-stage companies, in addition to not having to give up equity.
Venture debt is structured in a way where you know what to expect. With equity, valuations fluctuate, and in a depressed market things could look a lot less rosy for a founding team when an exit comes. With venture debt, you know what you’re raising and what it’ll cost you in the form of interest. And providing that you stick to your agreed terms, you’ll know what you’ll be repaying each month.
“Our main value proposition is that debt is cheaper than equity,” Spreng said. “And that’s really never been more true.”
But there’s a third advantage to venture debt over venture capital: time. Startups are tending to stay private or exit later in their journeys. Consequently, they are outliving their VCs’ funds. For a fund to realize the benefits of its investment, getting that startup into profitability and to an exit is critical. Managing with debt rather than raising more dilutive funding is even better.
“The venture ecosystem has come to accept debt, as a prudent and proper and wise part of capitalization of a growth company, particularly at later stages,” Spreng said.
Ultimately, you need to remember that whether you raise funds through equity or through debt, all money has a cost. What you have to determine is what you are willing to pay for it and at which stage of your company’s growth.