Non-convertible, senior secured loans are issued to venture-backed new-age firms in venture debt. Complementary to equity financing, it has numerous effective use cases for new-age enterprises, such as the following:
- Protects equity dilution
Companies can achieve significant levels of growth without needing to dilute their stock holdings if they use debt as a source of growth capital.
- Extends the runway between rounds
It is common to utilize debt to lengthen the runway between equity offerings. This indicates that future capital-raising efforts for businesses that are just getting started will be more successful.
- Finances the mismatches on working capital
It is possible to use it to finance the working capital needs of quickly expanding enterprises that call for considerable investment in current assets.
- Finances capital investments
When conventional bank financing is not an option, venture debt can be an invaluable resource for financing major capital equipment purchases and mergers and acquisitions of existing businesses.
- Creates a credit track record
Businesses can establish a consistent credit track record earlier if they employ a balanced capital mix consisting of loan and equity financing.
The structure of venture debts
“Non-convertible debenture” is used to describe the underlying financial instrument in venture loans (NCDs). NCDs are financial instruments issued by the borrower to a lender in the form of coupons. The lender purchases equity warrants of the borrower and this voucher instrument that they own. The holder of a warrant is granted the right, but not the responsibility, to purchase equity in the issuer of the warrant at a predetermined price and within a predetermined amount of time. Warrants are a form of security.
Considerations of venture debt funds before investing
To arrive at conclusions regarding investments, a fund will conduct research and analysis on the following significant aspects of the company and the sector:
- The capabilities of the company’s founders and its senior management personnel
Among the many attributes that funds look for in founders, some of the most important include experience in the relevant field, vision, and the ability to establish strong teams.
- The existing investors supporting the company
The caliber of investors and their propensity to continue providing financial backing to the business gives lenders a sense of relief and assurance.
- Established means of generating revenue and substantial profit margins
Companies that are experiencing rapid growth and have an established revenue model and healthy margins can carefully allocate debt to maintain their existing operations and scale. First and foremost, there needs to be a well-defined route to profitability.
- Market opportunity
For the company to scale, it must have a sizable addressable market, a solid product-market fit, and a clearly defined go-to-market plan to make responsible use of borrowed capital.
In addition to measures of the company’s business operations, the fund also considers the operational characteristics equally important.
In conclusion, prudent financial management is characterized by effective liquidity management and a strong liquidity position. Scaling a company necessitates a close working connection between the company’s financial backers and management. Without maintaining its data integrity, information is at best a degraded source. A solid foundation of trust must be established before the relationship may progress.