What is Growth Debt?
What is growth or venture debt and why is it important?
Growth debt, also known as venture debt financing, is a form of debt financing tailored toward high-growth companies. It is especially popular with venture-backed or growth-stage businesses. It provides access to capital for these companies to support their growth initiatives without diluting their equity ownership.
Early-stage companies rarely qualify for growth debt and instead, use other forms of debt financing, including convertible debt. Often startup companies will give up equity in the company during an equity raise.
Unlike traditional debt financing, growth debt lenders understand fast-growing companies' unique needs and risk profiles. Growth debt lenders provide loans with more flexible terms. These terms include lower interest rates, longer repayment periods, and the ability to convert debt into equity if certain conditions are met.
Companies often use growth debt to finance different growth opportunities. These opportunities include product development, business expansion, hiring key talent, acquiring intellectual property, or achieving significant milestones within a specific timeframe. It is an attractive option for companies that have positive cash flows but require additional capital to fuel their growth. Venture debt loans help early-stage, high-growth companies meet their growth milestones. Growth debt assumes a company is already exhibiting strong revenues.
With specialized banks and financial institutions offering growth debt, it has become a popular alternative to equity financing for venture-backed companies. It allows these companies to leverage their existing assets, track record, and growth potential while minimizing equity dilution and maintaining control over their business.
What is Venture Debt?
Venture debt is a form of debt financing designed for venture-backed companies. Specialized banks or financial institutions known as venture lenders provide it. Unlike traditional forms of financing, venture debt offers a flexible form of capital. This capital supports the growth and development of high-growth companies. It is synonymous with growth debt.
One key feature of venture debt is that it is structured as a loan rather than an equity investment. This structure means that the company does not have to give up ownership or control to equity investors in exchange for capital. Instead, the debt part of the financing is repaid over a specified period, usually with interest. Venture capitalists prefer dilutive investments which creates unnecessary dilution.
Early-stage or high-growth companies typically use venture debt to fund various activities such as product development, business expansion, key hires, or the acquisition of intellectual property. It can provide these companies with additional capital to seize growth opportunities without diluting existing shareholders.
Overall, venture debt provides an alternative source of capital for venture-backed companies, offering a balance of risk and reward. It complements equity financing and allows companies to access the capital needed to fuel their growth while minimizing dilution of ownership.
The benefits of using growth debt financing over equity financing
Growth debt financing offers several distinct advantages over equity financing for companies seeking capital to fuel their expansion. Unlike equity financing, where ownership and control are transferred to investors, growth debt allows companies to maintain full ownership and control while obtaining the necessary funds. This means that companies can avoid diluting existing shareholders and keep a greater share of the potential future profits. Additionally, growth debt is typically structured as a loan with a specified repayment period, allowing companies to manage their debt obligations more effectively. Often, this type of funding is a simple process that requires little more than access to financial data and strong revenues.
Most lenders provide companies with the flexibility to align their debt repayment schedules with their cash flow and growth projections. Moreover, growth debt can be a faster and more accessible option compared to equity financing. Overall, growth debt financing offers companies a flexible and efficient way to access capital without sacrificing equity and control, making it an attractive option for fast-growing businesses.
Here are a few reasons to use growth debt versus venture funding.
1. Maintain control of your business
Growth debt financing is an attractive option for entrepreneurs who want to maintain control of their business compared to equity financing. Unlike equity financing, where entrepreneurs have to give up ownership of their company, growth debt financing allows them to maintain majority ownership and decision-making power.
One of the advantages of growth debt financing is that lenders typically do not require a seat on the board. This is in contrast to equity financing, where investors often demand representation on the company's board of directors. By avoiding the need to give up board seats, entrepreneurs can preserve their autonomy and freedom to run their businesses as they see fit.
However, it is important for entrepreneurs to recognize that growth debt lenders expect on-time payments and meeting pre-agreed upon performance metrics. This provides them with reassurance that the business is on track and can fulfill its financial obligations. It also enables entrepreneurs to build a positive track record with growth debt lenders, enhancing their prospects for accessing additional capital in the future.
In summary, growth debt financing enables entrepreneurs to maintain control of their business, unlike equity financing. This flexible form of financing does not require entrepreneurs to give up board seats, allowing them to maintain decision-making power. By making on-time payments and meeting performance metrics, entrepreneurs can establish a positive relationship with growth debt lenders and secure continued access to capital for their growth opportunities.
2. Debt can lower your after-tax cost of capital
Debt can be a valuable tool for companies as it has the potential to lower the after-tax cost of capital. This is because interest and debt financing fees are tax-deductible expenses, which reduces the amount of income subject to taxes.
To illustrate this, let's consider a company with a 21% federal tax rate. If the company chooses to finance its growth through debt at a 10% interest rate, the interest payments would be tax deductible. This means that the after-tax cost of the debt would be lower than the stated interest rate. In this case, the after-tax cost of the debt would be 7.9%.
On the other hand, if the company decides to finance its growth through equity by offering a 10% dividend, there are no tax deductions available for dividend payments. As a result, the after-tax cost of the equity would be equal to the stated dividend rate, which is 10%.
Therefore, by employing debt financing, the company can lower its after-tax cost of capital compared to equity financing. This can make debt a more attractive option for funding growth initiatives, as it allows the company to access capital at a lower cost. By taking advantage of the tax deductibility of interest payments, companies can effectively reduce their overall financial burden and optimize their capital structure.
3. Quicker access to capital
Regarding financing the growth of a company, quicker access to capital can make all the difference. This is where growth debt financing comes into play, offering significant advantages over equity financing regarding speed and efficiency.
One of the key benefits of growth debt financing is the ability to raise funds in as little as 4-6 weeks, compared to the longer process involved in equity financing. This speed means that companies can quickly obtain the capital needed to fuel their growth initiatives and take advantage of time-sensitive opportunities.
By opting for growth debt financing, businesses can avoid the lengthy process of equity financing, which often involves attracting and negotiating with equity investors. This not only saves valuable time but also reduces the administrative burdens associated with equity financing.
Additionally, growth debt financing offers more flexibility and control over the company's operations and ownership. Unlike equity financing, where investors become partial owners of the company, growth debt financing allows businesses to maintain full ownership while accessing the capital needed for expansion.
Furthermore, growth debt financing provides a favorable after-tax cost compared to equity financing. Interest payments on debt are typically tax-deductible, reducing the overall cost of capital for the company. On the other hand, equity financing does not offer similar tax advantages.
In conclusion, growth debt financing provides quicker access to capital, saving time for business growth. Its efficient process, flexibility, and after-tax cost advantages make it an attractive option for companies seeking to fund their expansion and seize growth opportunities.
Growth debt is a simple way to avoid dilution for founders. Rather than depending on a venture capitalist, you can use a service like Liquidity to access non-dilutive capital quickly and effectively.