What's Below in Issue #47:
π° - An overview of venture term loans
π - Data behind VCs wanting exits
ποΈ - Latest podcast
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In the last edition of this newsletter, we focused on convertible venture debt. However, many other types of venture debt can fit your needs. In this issue we will focus on venture term loans - what they are, how they work, the benefits and drawbacks.
What are venture-term loans?
Venture term loans are a type of debt financing that is available to startups that have raised equity funding from venture capitalists or other investors. Venture-term loans are usually provided by specialized lenders, such as banks, hedge funds, or private equity firms, that have experience and expertise in working with high-growth companies.
Venture-term loans are generally structured as three-year loans (or series of loans) with warrants for equity. Warrants are options that give the lender the right to buy shares in your company at a predetermined price in the future. They can be used for runway extension, acquisition financing, project financing, growth capital, or equipment financing.
The interest rate on venture term loans is usually 0-4% higher than traditional loans to compensate for the increased risk to the lender. The loan also typically requires some form of collateral, such as accounts receivable, inventory, or intellectual property. The loan may also have covenants, which are conditions that the borrower has to meet or maintain, such as revenue growth, profitability, or cash flow.
Why are venture-term loans useful?
Venture-term loans are specifically useful when you have a clear picture of how to pay back the loan. This is often the case when you need a large capital expenditure that will lead to a steady cash flow. Term loans are usually non-convertible and, therefore, keep the cap table clean. There may be warrants for equity, but will usually be much smaller stakes than either equity offerings or convertible debt.
Additionally, it is still a type of venture debt, which means the classic advantages still apply:
When should you use venture-term loans?
Venture-term loans are not suitable for every startup or every situation. Here are some scenarios where you should consider using them:
How does the math behind venture-term loans work?
To illustrate how venture-term loans work in practice, let's look at an example:
Suppose you are raising $2 million in growth capital for your startup. You have two options: Option A is to sell 10% of your company for $2 million in equity financing; Option B is to take $2 million in venture term loan with an interest rate of 12%, a maturity date of 3 years, and warrants for 5% equity at a strike price equal to your current valuation.
Let's assume that after 3 years, your company is acquired for $50 million. How much money will you make in each option?
In Option A, you will own 90% of your company after selling 10% for $2 million. Your equity stake will be worth $45 million ($50 million x 90%) after the acquisition. Your return on investment (ROI) will be ($45 million - $2 million) / $2 million = 21.5x.
In Option B, you will own 100% of your company after taking $2 million in venture term loan. You will have to repay the loan and interest, which will be $2 million x (1 + 0.12)^3 = $3.12 million. You will also have to give up 5% equity to the lender, who will exercise the warrants at the strike price equal to your current valuation. Assuming your current valuation is $20 million, the lender will pay $1 million ($20 million x 5%) for the warrants and receive $2.5 million ($50 million x 5%) after the acquisition. Your equity stake will be worth $44.38 million ($50 million x 95% - $3.12 million) after the acquisition. Your ROI will be ($44.38 million - $2 million) / $2 million = 21.19x.
As you can see, in Option B, you end up making slightly less money than in Option A, because you have to pay interest and give up some equity to the lender. However, you also retain more ownership and control in your company, which may be more valuable to you than the difference in money.
Of course, this example is simplified and does not take into account other factors that may affect the outcome, such as taxes, fees, or multiple rounds of funding. However, it illustrates the basic logic and math behind venture-term loans.
Venture Capital Funding: Essential Things to Know About Venture Debt - π The Motley Fool
Understanding Venture Debt Financing - π SVB
Venture Debt: Benefits & How To Pick A Lender - π Saratoga
Data Corner
VCs are Creeping Back!
For the past few months, we've only seen VCs watching from the sidelines. However, the newest data from AngelList shows that pre-seed valuations have increased 8% from the past quarter. VCs are starting to deploy into the early-stage startups again after almost a year of holding back and falling valuations.
On the other hand, there is still bad news for later-stage startups as the average valuations have continued to fall. VCs are feeling the pain of portfolio companies' valuation cuts and are wary of startups at later stages.
This week on the #FundraisingDemystified podcast, we bring you Zach Bell, the co-founder and CEO of MyPlace.co, the groundbreaking social network empowering 20 million users to share their places and assets within trusted circles. Discover how Zach's innovative approach is transforming the way we connect and find unique places to stay based on recommendations from your networks.
Join us as Zach unveils the exciting developments and plans of MyPlace Co., shedding light on their one-of-a-kind social network that is transforming the way we share experiences with friends. Gain exclusive insights into his distinctive investor relations strategy, and uncover the lessons he learned in navigating a dynamic fundraising landscape.
Letβs dive into three key takeaways from this episode:
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Written by Jason Kirby - https://www.linkedin.com/in/jasonrkirby
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