A Better Way to Finance a Start-up? Venture Debt
We've discussed in previous columns the pitfalls of seeking traditional venture capital. Ordinary VC groups will provide much needed growth financing, but they will also dilute your equity ownership and have significant influence, if not effective control, over your strategic decisions and operations.
Last week we had a refreshing discussion about venture financing options with Ross Shelleman, CEO of Target Data. Target Data is a growing company based in Chicago that provides data services on the North American real estate market. The company aggregates a giant, robust, and timely data set of every property for sale and provides that data to companies that target movers and home buyers.
When Ross started Target Data five years ago, he funded it with his own capital and a small amount of bank financing to purchase the technology. As the company gained traction in the marketplace, Ross raised an A-series round of venture capital but was soon looking for additional sources of growth capital. He explored raising another round of venture capital but didn't like the idea of further diluting his own equity stake in the company or sharing control with an outside firm.
He then was introduced to Western Technology Investment (WTI), a Silicon Valley firm that provides venture debt financing to profitable, growing companies. As Ross described, "It was painless. We received $1 million in financing to grow our company without further diluting our current equity ownership."
WTI provided a loan to Target Data that provided an interest-only period up front, which is useful to bridge a growth cycle, followed by a payback period. WTI received warrants in Target Data that will convert to an equity position upon liquidation or change of control. But until then, Ross and the Target Data shareholders control the company.
When should you consider venture debt? It's not for everyone, so here are the things you need to keep in mind.
1. Venture debt works for growing, established companies with solid revenue and profitability. It doesn't work for early-stage companies or ventures with no clear path to pay back a loan.
2. Only consider venture debt if you need the capital for growth. If you can fund your growth through cash flow from operations, don't weigh down the company with debt of any kind.
3. If you can successfully raise capital through bank loans or lines of credit, they are probably a better option. Bank debt, including SBA loans, typically has lower interest rates, although they require assets, working capital or strong sustainable cash flows as support.
4. Venture debt is easier to get if you've already received some venture equity backing. The debt providers like to see that another investor has already taken a chance on your company. It helps to validate the decision that the business model is solid.
Growth capital is a necessity for most growing companies, but you never want to give up equity if you don't have to. Venture debt provides a viable solution for some companies and should be considered when possible.
Send us thoughts on your experience with traditional venture capital and whether you'd consider venture debt. We can be reached at firstname.lastname@example.org.
KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.