Venture capital can propel your company to hyper-growth. However, if you've already given away a significant amount of equity, you may not be able to afford further diluting your ownership.
The good news is that venture capital loans provide business owners with opportunities to work with investors without necessarily giving away more equity.
The advantages of venture capital loans
Between bootstrapping your business, applying for a working capital loan, going to a bank, or securing venture capital loans, the latter option has a certain appeal. While applying for funding can be time-consuming, venture debt has an array of advantages and uses. Some of these benefits include:
- No personal collateral
- The ability to raise large sums of money
- Support and advice from your investors
- Likelihood of increased exposure
- Networking and team-building
- Collaborations with other businesses
In other words, venture capital loans are about more than just money. Rather than borrowing from a lender, you get a business partner who has a vested interest in your business.
Risks of venture capital loans
There can be risks associated with venture capital loans, especially considering that there’s no guarantee your business will succeed. You may face several challenges, particularly if your startup is not in a rapid growth stage.
Taking on venture debt rather than giving equity means that the venture loan is considered "senior debt". Therefore, the capital loan is first in line for payment. While it may not involve personal collateral, venture capital lenders can seize business assets or liquidate the company if repayments are not made.
With these risks in mind, venture capital loans should be considered when your company is looking to:
- Fuel growth
- Extend your runway between financing
- Increase your valuation
- Deepen liquidity
- Structure your working capital
Understanding venture capital debt
The best way to conceptualize venture capital debt is to look at it as another form of working capital financing. While it’s less restrictive than a traditional bank loan regarding eligibility and requirements, individual lenders will have their individual needs.
At the same time, it's essential to look at how venture capital loans differ from traditional small business loans:
- Underwriting - The way banks and venture capitalist investors analyze potential investments is vastly different. Consider the application process for a small business administration (SBA) loan; the lender will scrutinize your business and personal accounts, credit score, cash flow, current assets, current liabilities, and other critical business details.
This loan application process makes it almost impossible for a startup or early-stage organization to get a business line of credit. On the other hand, venture lenders base their approach on your track record, business model, technology, strategy, and how much financing your company has raised in the past.
- Warrants - Unlike traditional business capital, venture investors may ask for the exclusive right to buy company stock at a fixed price. This component provides more incentive for the investor while keeping the interest rates low or competitive with bank loans.
- Terms - Unlike SBA loans, which can be extremely difficult to get approval for, venture capital loans typically have flexible terms. For example, the SBA 7(a) loan has a maximum interest rate of 2.75% with a seven-year term for working capital. Venture capital can run from 0% to 9% interest, with three to five-year terms.
However, it's important to remember that government loan programs or online lenders only provide capital. If your startup needs more than the money itself, the additional interest can be well worth the cost.
How to secure a venture capital loan
The process of obtaining a venture capital loan can be time-consuming. However, this comprehensive process is vital if it's the right loan for your business.
Firstly, research different venture capital firms. Every investor tends to focus on a specific area or sub-niche. For example, firm A might specialize in funding healthcare SaaS products, while firm B has a portfolio made up of fintech products.
Next, connect with prospective investors. The best way to do this is through a warm introduction, such as having a mutual friend or colleague introduce you both.
Once you have the opportunity to pitch your business or idea, you'll need to have an elevator pitch ready as well as a strong pitch deck. Aim to sell your vision, talking about your achievements to date, and why you are looking for a venture capital loan.
If your pitch is successful, you will need to set time aside for meetings and be prepared to get into more detail. Potential investors may want to discuss their proposed term sheet, perform due diligence, and finalize the investment. This entire process can take several weeks, if not longer. Learn more about the process here.
What happens after the deal is closed?
When applying for any loan, lenders will want more than a balance sheet. Keeping your financial operations transparent and accurate is a crucial way to ensure you always have access to capital for operating needs or unexpected expenses.
After securing a venture capital loan, you can use your working capital for operational and business expenses as long as you adhere to the term obligations.
Having venture capital backing can jumpstart your business growth, providing you with a business ally and partner. Having a seasoned investor in your court can bring peace of mind as you focus on driving revenue and developing your product.