This post is the third in a three-part series. Read Part 1: Background and Choices and Part 2: Bank Loans vs. Insured Technology Financing.
Venture debt is an increasingly popular option amongst entrepreneurs as many seek alternative funding opportunities, often bridging a company from one growth stage to the next. Venture debt is a form of debt financing specifically geared to fast-growing technology companies. Similar to a bank loan, venture debt is most often used for growth capital, with a specified term and interest only period, but the similarities don’t extend much beyond there.
While traditional loans rely on tangible assets as collateral, venture debt does not, opening doors to greater amounts of capital. However, it comes at a greater cost, by means of higher interest rates, fees, and warrants.
Venture Debt
Venture debt provides liquidity to companies that may lack the tangible assets required of a traditional bank loan, and often with greater flexibility. While it is not 100% reserved for venture-backed companies, it is significantly easier to obtain with VC-backing, as well as more affordable.
That affordability should be considered in context, however. Venture debt has significantly higher interest rates than bank loans, typically between 12-15%. These rates increase, often exponentially, for companies without traditional backing. While VC-backed companies certainly have more financing options available to them, for those without that type of sponsorship, it comes down to how much an entrepreneur is willing to pay for financing.
In addition to interest, venture debt is subject to a number of fees, most unavoidable. A borrower is often required to pay both a closing fee and an exit fee/ success fee, for example, which are one-time extra percentages for initiating the loan and then repaying the debt, respectively. Companies are also charged a prepayment fee if they were to pay off the venture debt before the term ends. These fees, which seem to penalize a company for doing well, are all on top of warrants, which entitle the lender to the company’s stock.
Warrants are securities that allow the holder the right – but not the obligation – to purchase stock in a company at a specified price within a certain period. This is where venture debt can get expensive and lead to dilution of equity – and requires a bit of foresight from an entrepreneur. The amount is variable depending on each business and its future revenues. Not only can warrants lead to considerable dilution of equity, but for a very successful company going public it could result in millions of dollars in warrants.
PIUS’ Insured Technology Financing
As discussed in Part 2, PIUS’s interest rate is based on market rates, similar to banks, with an overall cost of capital of about 10%, which includes the cost of the insurance. Venture debt firms aim to get the highest return reasonably possible for limited partners – in fact, that is their responsibility. As the insurer, however, PIUS’ goal is simply to see the loan paid back, so it is in PIUS’ best interest to offer the lowest cost of capital possible. PIUS does this by approaching the capital markets on behalf of the borrower, where lenders are assessing the risk of an A+ rated insurance company, rather than the borrower individually.
Unlike venture debt, PIUS does not charge fees or penalties. Because PIUS’ primary goal is repayment, the focus remains on helping a company successfully exit the transaction. PIUS works with a borrower from start to finish, and in a situation where things could take a downturn, PIUS works with both the borrower and the lender to find the best possible solution for all parties.
Likewise, PIUS doesn’t require warrants. With venture debt, the thought is that if a borrower defaults on a loan and can’t pay it back, the venture debt firm is making money on warrants from other portfolio companies, balancing out the loss from any one borrower. On the other hand, PIUS is made up of IP experts, so if a borrower defaults, PIUS can monetize the IP if needed. In the event this becomes necessary, it is customarily done in cooperation with the borrower. Beyond this, PIUS’ evaluation process is much more thorough than any other financing application. While the selection process is meticulous, PIUS’ evaluation ensures its borrowers have an incredibly high probability for long-term success.
When it comes to alternative financing sources, companies without traditional venture backing tend to have less opportunities and pay higher interest rates, but choices do exist. When considering the best route for any company, an entrepreneur should take into account three main considerations in weighing the options: price, structure, and dilution. PIUS’ insured technology financing provides a comprehensive lending solution for fast-growing technology companies. While the insurance means borrowers get more capital at better rates, they also have a partner in PIUS, that is on their side for the entire life of the loan and beyond.