Venture Debt –
the key facts at a glance

Key facts at a glance:

• Venture debt is debt capital for young, rapidly growing companies to finance projects with elevated risk.

• Risk investors pool money in funds and provide short- to medium-term loans to growth companies without acquiring company shares.

• Suitable for scale-ups that do not wish to issue additional company shares.

• Prerequisites include a completed major funding round, a market-ready product, a relevant market position, an existing customer base, a break-even point that has been reached or is near, experienced management, and a promising business plan.

• Venture debt provides liquidity for growth projects such as advance financing of orders, procurement of operating resources, hiring of personnel, expansion of sales and communications, and further development of the business model.

• Interest rates are often above one-tenth of the loan amount, contracts are complex and accompanied by covenants. An additional profit participation for the lender ("equity kicker") is frequently provided for.

What Exactly Is Venture Debt?

The term is composed of the English words for "venture" and " debt capital" (debt). This already clearly illustrates what venture debt is about: it is debt capital provided for projects with elevated risk. It is typically granted to companies that are on a strong growth trajectory.

How Exactly Does Venture Debt Work?

For this "venture debt capital", money from risk investors is pooled in a fund. From the funds thus available, capital is provided in the form of short- to medium-term loans to young growth companies. This type of lending originates from the Anglo-Saxon world and has, for example, secured a firm place in growth financing in the United States. In Germany, by contrast, it is still relatively new.

Unlike classic venture capital, venture debt does not involve acquiring company shares — it is usually purely debt capital. This is important for companies beyond a certain growth stage. The reason is that new equity providers with decision-making rights cannot be continually brought into the company without diminishing the influence of the existing management and shareholder team.

Prerequisites for Venture Debt

Venture debt is particularly suited for young companies that have moved beyond the early start-up phase, known as scale-ups. They are increasingly seeking debt financing to avoid having to issue further company shares.

Typical debt capital from banks, however, is often not yet available for scale-ups due to their risk structure and frequently lacking collateral. Venture debt can therefore represent an alternative. However, several prerequisites must be met for this type of capital:

• The company has already completed a major funding round and has an investor on board

• The product or service has proven to be market-ready

• There is already a relevant market position and a customer base — both can be further expanded

• The revenue break-even point should have been reached or be imminent — i.e. the scale-up is already generating profit or will do so in the foreseeable future

• The management has experience, and there is a promising business plan for the coming years

Opportunities and Limitations of the Financing

Venture debt can provide scale-ups with the necessary liquidity to realise their growth: orders can be advance-funded, operating resources procured, personnel hired, sales and communications expanded, or the business model further developed.

However, this flexibility does not come cheap: interest rates for venture debt financing are usually above one-tenth of the loan amount. In addition, the contracts are complex, often in English, and frequently accompanied by covenants.

Important to note: with venture debt — despite being debt capital — an additional profit participation for the lender is usually also provided for. This is known as an "equity kicker".