Venture Debt vs Venture Capital

Businesses that are just starting depend increasingly on venture debt and venture capital to help them grow. In venture capital, investors put their money into companies with a lot of development potential. In return, the investors access knowledge, connections, and skills. On the other hand, venture debt financing is a great alternative to equity financing for firms that don’t yet meet the requirements for typical bank loans.

With their ability to tackle issues like information asymmetry, high levels of unpredictability, and the necessity for strategic development assistance within the startup ecosystem, these funding solutions have become more important.

It’s important to understand the difference between venture debt and venture capital before getting into the venture debt vs venture capital debate.

Key Difference Between Venture Debt and Venture Capital

A few distinctions highlight the strategic roles of venture debt vs venture capital in the startup ecosystem, offering diverse options for founders to finance their growth while managing control and ownership of their companies.

Let’s look at the difference between venture debt and venture capital here.

Investment Types

Venture Capital is an equity investment where investors receive ownership stakes in the company. This form of financing provides startups with capital in exchange for a percentage of the company’s equity, thus making investors part-owners of the business.

One difference between equity financing—which entails selling a stake in the company—and venture debt financing is the interest that must be repaid. This is a financial obligation that the firm must satisfy, usually within 3 to 4 years, and does not involve selling an interest in the company.

Needed Skills

Even without revenue, startups with significant growth potential are often eligible for venture capital. With an eye on future development rather than present profitability, venture investors seek businesses that can stir up existing markets or establish new ones.

Companies usually need revenue or growth indicators to be eligible for venture debt financing. Businesses already profitable or have a clear path to profitability are good candidates for this investment.

Ownership Diluting

Venture capital investments might greatly diminish the founders’ ownership stake. If you want to get investment from venture capitalists, you’ll have to give up some ownership, and maybe even some say in how the firm is run.

Minimal equity dilution is usually associated with venture debt financing. As a condition of the loan, lenders may ask for options, which means they can buy the stock later. Equity dilution, nevertheless, has a far lesser overall impact than venture capital.

Repayment schedule

Repayment is not made directly to venture capitalists. The goal of most investors is to earn a return on their capital through the sale of shares at a greater value, which can happen through an acquisition or an initial public offering (IPO).

Venture Debt financing requires the borrower to repay the principal and interest within a certain term. This payback is usually spread over a few years and doesn’t rely on how much the company’s stock is worth at any given time.

Requests for Refund

You risk losing a lot of money if you invest in venture capital. The investment’s performance highly depends on the company’s development and capacity to accomplish a profitable exit event.

Venture Debt financing offers lower returns but carries lower risk than venture capital. The returns are limited to the interest on the loan and potentially modest equity participation through warrants, providing a more predictable, though generally lower, return on investment.

This table outlines the key differences between venture capital and venture debt:

Example of Venture Debt

Instacart, the grocery delivery giant, utilized venture debt effectively to fuel its rapid growth in 2015.

Financial Timeline

• 2012-2014: Instacart raised approximately $154 million in equity funding through Series A, B, and C rounds, but it needed additional capital to expand its services and develop the technology.
• 2015:
  • Secured a $40 million venture debt facility from Silicon Valley Bank, a non-dilutive alternative.
  • Achieved significant growth and secured a $200 million Series D equity round at over $2 billion valuation.
• 2015-2016: Repaid the venture debt successfully.

Financial Impact

Venture debt allowed Instacart to access $40 million in capital without further equity dilution.
The interest rate on the debt was likely in the range of 8-12%, lower than the cost of additional equity.
The loan extended Instacart’s cash runway by 6-9 months, enabling it to achieve key milestones and raise a larger equity round at a higher valuation.

Example of Venture Capital Funding

Moderna, a biotech underdog founded in 2010, harnessed VC muscle to transform from mRNA dreamer to COVID vaccine champion, redefining medicine one genetic snippet at a time.

Early Funding

• $40 million in Series A funding from Flagship Ventures in 2013
• $110 million in Series B funding from a group led by Fidelity Biosciences in 2014
• $450 million in Series C funding from a consortium of investors in 2015

Later Stage Funding

• $500 million in Series D funding led by AstraZeneca in 2018
• $474 million in additional funding, including a private investment from the Abu Dhabi Investment Authority in 2020

Breakthrough

• Moderna’s mRNA-based COVID-19 vaccine, developed with support from VC funding, received emergency use authorization in the United States in 2020.
• It became one of the most successful vaccines in history, crucial in the global fight against the pandemic.

Advantages and Disadvantages of Venture Debt and Venture Capital

Venture Debt vs Venture Capital, each offers unique advantages and comes with its challenges for startups. Here’s a concise overview based on the insights gathered on when to choose venture debt and venture capital:

Let’s understand venture debt qualifications by breaking down its advantages and disadvantages.

Advantages

• To keep more of the company’s ownership for the founders, venture debt financing is a great way for companies to avoid diluting their stock.
• Despite its high interest rates, venture debt financing is frequently less expensive than selling stock, particularly when considering long-term equity expenses.
• It helps entrepreneurs avoid down rounds by giving them some breathing room between financing rounds so they don’t seem as frantic for cash.
• Compared to more conventional loan or equity financing options, the procedure for obtaining venture debt financing may be shorter and need less documentation.

Disadvantages

• Startups have the challenge of regularly scheduling financial withdrawals, which can limit their capacity to spend freely in growth.
• Venture debt financing might put existing investors in a difficult position since they may have different claims on the company’s assets in the event of a collapse in the economy.
• Startups risk default and, worse, insolvency if they cannot fulfill the repayment plan.
• Unlike with certain equity investors, venture debt financing conditions are typically rather rigid regarding repayment.

Advantages and Disadvantages of Venture Capital

Here are the advantages and disadvantages of venture capital.

Advantages

• Startups may access large sums of money to fuel their expansion and growth.
• Venture capitalists are a great resource for learning about the business world, finding a mentor, and expanding your professional network.
• Investment opportunities, business associates, and other professionals in your field can be found inside your extensive network.
• Facilitates quick scalability without the immediate need to repay loans.
• Mitigate risk by dividing up the company’s potential losses among the venture capitalists who have a financial interest in the startup’s success.

Disadvantages

• Founders frequently have to give up some of their stock and decision-making power, which can be a loss of control.
• Accepting venture capital money dilutes the ownership position of current shareholders.
• There is a lot of pressure on companies from venture capitalists, who want to see substantial returns within a certain timeframe.
• There may be fewer strategic choices available to the company if it has to conform to the exit strategy of its venture capitalists.

When to Choose Venture Debt?

Venture debt financing might be the right choice for your startup if you’re at a point where you need a quick cash injection without wanting to dilute your equity significantly. This type of financing is ideal for startups with a clear path to profitability and those that have already secured venture capital backing.

It’s particularly useful for extending your cash runway between funding rounds, for specific projects, or when you’re aiming to raise capital at a higher valuation in the future. However, it’s crucial that your startup has a solid plan for using the capital effectively and can handle the repayment schedule without straining your operations. Key points to consider for venture debt qualifications include:

• You require more funding without diluting your venture capital backers.
• The capital will be put to good use by your startup right away, either to fuel expansion or to lengthen your runway.
• You know your financial capacity to repay the loan with interest and principal on schedule.
• You want to bridge a gap to a significant equity round or other financial milestone​​​​.

When to Choose Venture Capital?

Startups have a lot of potential for quick growth while just starting out. However, they frequently seek venture capital because they do not have the income or assets to be eligible for bank loans. Venture capital can be right if your company is in an investor-friendly industry like biotech or technology, and you are ready to swap shares for considerable financing, direction, and investor contacts.

This is the route to take if you need powerful individuals to help you and your company grow, in addition to financial backing. You should consider venture capital if:

• For a considerable sum of money, you are willing to part with a portion of your company’s ownership.
• You understand that venture capitalists can be an invaluable resource for your company regarding information, contacts, and money.
• Your business model and growth plans align with the high-risk, high-reward expectations of venture capitalists.
• You’re okay to lose some level of control over your company’s decisions and direction​​.

Manage Your Company Equity with Eqvista!

Consider your firm’s needs, growth stage, and long-term goals when choosing between venture debt vs venture capital. Use venture debt financing if your company has built momentum and wants to prolong its financial runway or support new projects without significantly reducing ownership.

On the other hand, venture capital is ideal for startups in their early stages with significant growth potential. Venture capitalists provide financial support, access to various resources, and domain expertise in exchange for stock.

Eqvista offers services to help your firm effectively manage its equity, including 409A valuations, share issuance, and cap table management. Our technology assists entrepreneurs with efficient and straightforward equity management.

We also help with Financial modeling, electronic share issuing, and adhering to reporting and analysis standards. To learn more about how Eqvista may help your startup, contact us!