Insights provided by BOOST&Co's Ria Hopkinson
We explain why this type of fast, flexible funding is ideal for businesses that struggle to gain funding from banks
At BOOST&Co, we’ve specialised in providing venture debt to UK-based SMEs since 2011, but one of the questions we’re frequently asked is “what does ‘venture debt’ mean?” It’s a form of fast, flexible funding that’s proving more important than ever amid the coronavirus pandemic, so here, we aim to demystify the topic, giving you all the facts in case venture debt could work for you. BOOST&Co offers venture debt in the form of term loans, through its existing product and also via the government’s Coronavirus Business Interruption Loan Scheme (CBILS) – but more on that later. First, what exactly are we talking about here?
So, what is venture debt?
Venture debt is funding aimed at high-growth scale-ups, provided by specialist lenders. These types of loans are particularly effective for SMEs that are yet to achieve profitability but have an established business model and clear prospects for growth. Funding is available earlier and in larger amounts than traditional bank loans, and these loans do not require personal guarantees – so if you have an innovative company that is expanding rapidly but needs investment to secure its next stage of growth, venture debt could be ideal for you. Fast-growing young businesses with a limited trading history and little or no track record of profitability usually struggle to borrow money from conventional sources, even when their futures are bright. Banks are generally wary of the risks posed by these start-ups and tend to steer clear (as seen in their initial reluctance to provide CBILS loans to SMEs).
Beyond the banks – alternative funding for SMEs
Despite tough trading conditions and ongoing uncertainty around both Covid-19 and Brexit, entrepreneurs retain a healthy appetite for establishing start-ups, with a record number – almost 700,000, a 2.8% increase on the previous year – being founded in 2019. But how do fast-growing companies fund ambitious growth strategies, at a time when banks’ support for SMEs is declining? Many business founders believe that the difficulty of securing loans from banks leaves them with few options. They often feel that they need to raise equity capital to fund future growth, thus giving up a large chunk of ownership and possibly even ceding control to their investors. But venture debt may still be available to start-ups with a viable business model and strong prospects for growth, and these loans are aimed at just this sort of firm.
Why venture debt is available when bank loans are not
The products available from non-bank lenders such as BOOST&Co combine the traditional features of a loan with aspects of venture capital that have traditionally been the preserve of investors offering equity finance. These are potentially attractive to start-ups and high-growth companies that do not yet have the type of positive cash flows that banks look for, or the valuable assets that banks typically expect borrowers to put up as collateral against their debt. This is not to suggest that venture debt is suitable for start-ups with no track record or no significant revenues or assets. Lenders will want to see that your business is already generating strong revenues (BOOST&Co, for example, looks for a revenue rate of £2m). They will also assess the company’s enterprise value, as well as making a judgement about its future prospects for growth. Nevertheless, this sort of funding is open to young and relatively immature businesses, even though bank finance may not be an option, because venture debt providers are interested in the current and expected performance of a firm, rather than its historical financial performance.
The cost of venture debt is tailored to you
Growth capital loans tend to be priced individually, depending on the needs and circumstances of the borrower (for example, companies at an earlier stage of their development or with a faster cash-burn rate will normally pay more). Venture debt typically incorporates three elements: a fee of between 1% and 2% of the approved loan amount, an annual interest rate of between 10% and 12%, and an equity kicker worth 10% to 20% of the loan. This final element is usually structured as a warrant, giving the lender the right to buy a small portion of equity at a fixed price during the term of the loan. BOOST&Co’s term loans range from £2m to £10m and are typically repayable over periods from 36 to 60 months. Loans can be structured to suit the borrower: some businesses prefer to draw down funding in tranches, as and when they need the money, which reduces the total interest cost. Although repayments usually include both interest and capital, some borrowers opt for an interest-only period of between six and 12 months at the beginning of the loan. Some loans include covenants that the company must meet, but others do not. Of course, venture debt is not suitable for every young business. It may appear to be more expensive than traditional bank finance, but it does provide fast-growing SMEs with access to non-dilutive debt that can be used for various types of growth.
How to use venture debt
Venture debt is an appealing alternative for scale-ups in need of growth capital because it provides more funding, faster and earlier in a company’s life cycle, and without the use of fixed criteria, ratio-testing or covenants. After a lender has designed a loan specifically for your business, you can use it in a number of ways. These include:
Extending your cash runway Venture debt can provide a useful source of headroom for a loss-making company as it closes in on profitability. Because venture debt lenders focus on a firm’s enterprise value and business model rather than its historical financial performance, businesses do not need to be profitable to be eligible for these types of loans, although they must be generating revenues when they apply. Funding M&A activity Fast-growing businesses often plan to increase their speed of expansion by implementing a growth strategy based on mergers and acquisitions. However, this model means that companies must have finance in place to enable them to respond quickly when new opportunities arise. Once secured, venture debt can be drawn down over time, making it perfectly suited to acquisition growth strategies. Providing working capital High-growth businesses that are yet to break into profit must carefully manage their cash flow, but they will occasionally need to raise funding for working capital requirements, such as stock purchases. It can be particularly difficult for relatively young businesses to manage these needs where they vary by season. The flexibility of venture debt makes it well-suited to this purpose. Supporting capital expenditure Fast-growing businesses often struggle to fund the investments that would secure further growth. These can include the purchase of equipment or the cost of software licences. Venture debt can be a handy tool in financing such needs – and because venture debt loans are offered in tranches, SMEs are able to plan for future investments, too.
Why venture debt is perfect for scale-ups
SMEs form 99.9% of the 5.9 million businesses in the UK, so it is vital that we encourage entrepreneurs to start businesses and to drive them to the point of scalability. How can we do this, and how can scale-ups secure the capital to support their growth, be it in the form of venture debt, equity or traditional bank financing At BOOST&Co, we believe that to support a business, you have to know a business. So here’s a look at how we define a scale-up that is ready for venture debt.
Gearing up for growth – what you need to apply
Preparation is the key to securing growth capital from a specialist lender. Make sure you’re prepared when you apply and you’re halfway there. Be sure to have the following documents ready for review: -Financial information -Company profile -Business model -Market analysis -Management team profile -Funding needs -Plans for servicing debt in a downside scenario -Business goals For more details, take a look at the illustration below, which shows the eight factors we consider most important for businesses preparing to apply for growth capital.
Four businesses we’ve helped using venture debt
BOOST&Co has been providing venture debt and growth capital loans to exciting, fast-growing companies since 2011, having already worked with more than 500 high-tech and innovative businesses that needed funding to move their enterprises forward.
We have worked with a range of firms that wanted to raise venture debt for a variety of reasons: to bridge the gap to breaking even, to extend their cash runway before an equity round, for mergers and acquisition, for working capital or to open new sites. Here are just four examples of companies we’ve helped to grow. Simfoni Simfoni is a next-generation digital solutions provider for procurement professionals, with regional offices in Chicago, London and Dubai. The spend analytics and buying automation business specialises in driving operational improvement and cost reduction for its customers, which include a variety of blue-chip consultancy firms. BOOST&Co provided Simfoni with a £2m growth capital loan, which the company is using to expand both its operational base and its sales and marketing teams. Read more