When considering financing for technology startups, we can generally categorize companies into two distinct groups – sponsored and unsponsored.
Simply speaking, a sponsored company is one with one or more institutional investors, typically venture capitalists. In exchange for its investment in the company, the sponsor typically secures ownership equity in the company, and frequently, they may also negotiate some control or governance over a business, such as a seat on the board of directors.
So, what does it mean to be an unsponsored company? Knowing an unsponsored company does not have the financial backing of an investor, at face value, may seem these companies are at a disadvantage. While sponsorship comes with expertise and often additional rounds of funding, it also comes with a dilution of equity, and sometimes, the founders have less of a say in the business’s future.
As we’re seeing an increasing number of individuals opting for entrepreneurship, we are also seeing increased demand for alternative sources of funding.
A recent study from The Brookings Institution found that while VCs provided more than $164 billion to technology startups in 2020, venture capital accounts for less than 1% of funding for new businesses in the United States. Additionally, VC investments are still heavily focused geographically in Silicon Valley, New York City, and Boston.
We know that great ideas can come from anywhere, however, and as we see innovation coming from geographic regions across the country, we’re seeing many entrepreneurs opting for different – and sometimes unconventional – financing solutions. Likewise, these companies are creating jobs and driving their local economies, and they don’t have the obligations to investors as we have more historically seen in technology startup funding.
With more entrepreneurs taking a less conventional approach to business – whether by concept, geography, or both – they are also opting less for traditional funding options. Given the choice, entrepreneurs tend to favor debt because it is non-dilutive and allows them to maintain more ownership, as opposed to venture capital. While bank loans and venture debt may appear similar, in that they are both debts to be repaid, they are in fact disparate in volume and eligibility.
Bank loans are more commonly understood by the average consumer and can be used for anything from a car to a home mortgage, or in a commercial sense, to finance a business. With a bank loan, an entrepreneur can secure an amount of money if there is enough collateral to use as security for a term loan. The loan is paid back in installments with interest, and while this interest comes at an expense, it is generally much less expensive than other financing options. However, because banks are risk averse by nature, it is difficult to get funding in large enough amounts to grow a business as necessary.
Venture debt, on the other hand, is often utilized to fund growth between equity rounds. While venture debt can typically be secured in much larger amounts than traditional bank loans, it is also significantly more expensive, and is almost always reserved for companies with venture-backing – making it a non-starter for companies that have chosen not to pursue VC funding.
Venture backing certainly opens doors as lenders often rely on the sponsor as a secondary source of repayment, should things not go according to plan. Venture debt is usually supplemented with bank financing, leaving a business with two different credit facilities to manage. In addition, there are often warrants attached to the financing, as well as origination fees, prepayment penalties and other costs and expenses. As a result, entrepreneurs are exploring, more and more, alternative funding options that go beyond traditional forms of debt.
PIUS’ proprietary insurance product enables growing start-up companies to secure better financing options by utilizing a company’s intellectual property as collateral, ultimately facilitating greater loan amounts at better rates. And while the process is quite a bit more selective, thoughtful analysis on a company’s intellectual property can be one of the best ways to predict a business’s success over time.
In parts 2 and 3 of this three-part series, we will examine bank loans and venture debt in greater detail, both alongside PIUS’ proprietary insured technology financing. Follow along and check back for the next installment.