https://www.mergersandinquisitions.com/engineer-to-venture-capital/

Startups have an overdose of several things – ideas, energy, and promise. If they lack something, it is money. Especially in its early stages, a startup does not really have a dependable revenue stream, but it has to keep spending for everything that will make the business grow. Let us look at some of the unavoidable expenses that a startup has to bear and how entrepreneurs can acquire funding for the same.

Seed Money

It is the initial amount of money that a business needs in the first few months before anything has happened in the way of putting a revenue structure in place. The setup costs would include building a website, printing visiting cards, and buying minimal office equipment. Typically, this money comes from the savings of the entrepreneurs, and once it is in place, the efforts to attract sizeable capital can begin in real earnest.

Working Capital

As soon as the company is set up, operations would commence. Running a business requires money, and that includes the day to day expenses, also called working capital. Even if a startup has three employees to start with, they would need to be paid salaries. Similar running expenses would go into paper for the printer, electricity bills, phone bills, conveyance for business calls and much more.

Expansion

Next are the more significant expenses for getting the company running, and that may include things like designing prototypes or setting up research facilities or appointing business partners or even additional employees.

Deposits

Getting a bank loan is always challenging for a startup that is just a few months old, but even if it manages to qualify for one, the owner would have to provide some manner of collateral or deposit, which might cost money as well. If you are going in for a 7(a) loan, for instance, under the Small Business Administration, you still have to provide 25% of the amount from your side.

What is venture capital?

A startup then goes out seeking venture capital. It is a form of financing that is typically provided in return for a share of the company, which is referred to as equity. That works for entrepreneurs because they will not be in a position to repay a loan immediately along with interest. So it makes more sense for them to give a share in their company instead. It is the most popular route startups aim for when they look for funding.

Venture equity funding is provided in multiple stages called rounds. Such rounds occur after the startup achieves critical milestones in its planned lifecycle. These milestones could be in linked to the acquisition of a certain number of customers, completion of certain regulatory approvals, establishment of a presence in specific locations and more. However, in recent years, another type of venture funding has been introduced to startups, and it is called venture debt.

What is venture debt?

Venture debt is additional funding (of a much smaller amount) that is provided to a startup which already enjoys venture equity funding. As explained above, the venture equity funding would be given once the startup achieves certain milestones. However, the need for smaller funding could arise in between these milestones, because there are not enough revenue streams yet to sustain those intermediate expenses. Let us look at a few distinct advantages of venture debt.

Preservation of Equity

In exchange for venture equity funding, the entrepreneurs have to pledge a particular part of the ownership of their company to the venture capitalists. While that is a necessary price to pay for getting substantial funding, when the startup is a little older and has a better capacity of servicing a loan, a venture debt seems like a better way to arrange for funds without losing any further control of the company.

Fresh Valuation Not Needed

When a venture capitalist first assesses a startup, it needs to see its valuation so that it can decide the funding accordingly. Since a startup would not be worth the estimate it is labeled with, at least in its initial years, the valuation would not just be a matter of adding up the numbers on a balance sheet. Many intangibles will also need to be taken into account, which makes it a tedious process. However, venture debt is much more straightforward, since it does not require the entrepreneurs to provide any valuation of their company.

The Wheels Keep Turning

The periods in between two rounds of venture equity funding are pretty painful for any startup. First, the expenses do not go away in the interim, and sometimes the situations require more money than the revenue streams are able to provide. Second, the requirement of funds in these periods might not be as big as funding round, so the venture capitalists would not be too interested. However, a venture debt helps to keep the business running and the cash flow going until the next round of funding is received.

As an expert, “a venture debt is a perfect way to ensure that the milestone for the next valuation is achieved, without further erosion of the equity stake of the entrepreneurs.”

Into The Mainstream

A venture debt would also create a repayment history for the startup, which adds to its financial credibility in the traditional banking institutions. After several years, when it is not using venture capital anymore and is more or less self-sustaining, an unforeseen event could cause a need for funds. In such situations, the startup could show the repayment record for the venture debt and apply for a traditional bank loan.

The media keeps discussing and highlighting the venture capitalists and the number of rounds of venture capital funding that a startup has got. However, venture debt has been quietly making its presence felt in the startup community. When the startup has survived the first few tumultuous months, and there is reasonably steady cash flow, venture debt is a perfect solution for working capital requirements.

When an entrepreneur applies for and obtains venture debt funding, it is a sure sign of the improved credibility of his/her company because it is given only on the promise of principal and interest repayment, without giving away any ownership of the company.