Venture capital has changed direction. As the “lean startup” model fuels entrepreneurial tech activity, many VCs are turning to early stage investments. Lean tech startups need less capital than in the past, so fund sizes are falling.
That’s fine if your company is what the industry calls a “home run” or fund returner. But if you’re what we call a “base runner,” this shift in direction can be problematic.
These solid, venture-backed companies are safely on base, but are five to eight years into the funding cycle. Base Runners have outstanding management teams, great products and growing markets. Unfortunately, many Base Runners need a hit to drive in the run. They’re often short on the growth capital they need to single or double to the next milestone and, ultimately, drive home to a successful exit.
Despite Base Runners’ inherent promise, existing investors may find it difficult to finance a large growth round from reserved capital. Outside capital is scarce as fewer VCs invest in late-stage companies and funds shrink.
Today, many Base Runner companies are taking a different approach: Financing growth with venture debt to hit singles and doubles.
Cost-effective and minimally dilutive, venture debt complements existing equity investments and ownership interests. It also gives Base Runner companies maximum flexibility to take advantage of opportunities.
Less Dilution, Less Disruption
Venture debt has been available for many years. It has traditionally been used by startups to finance equipment or extend runway between early equity rounds. But that’s changing.
Today, venture debt is becoming an important source of scale capital for Base Runner companies. Its growth potential is comparable to equity – yet venture debt imposes significantly less dilution and disruption.
Base Runner companies that need capital (and their investors) are understandably wary of additional dilution. Financing with venture debt incurs only about 1/10th the dilution of equity.
Further, venture debt sits outside the cap table. It doesn’t upset existing ownership percentages or liquidation preferences, nor does it force “pay to play” financings on syndicates that may have limited reserves to protect their hard-earned interests.
Big $, Flexible Uses
Today, a Base Runner company might be able to secure up to $20 million of venture debt capital with a one-year interest-only period (or longer).
That’s enough growth capital to make a significant difference, especially because venture loans are so flexible. A company can use venture debt to fund strategic acquisitions, develop new products, expand sales and marketing or grow to sustainable cash-flow positive.
Further, venture loans don’t have the restrictive covenants associated with bank financing. So a Base Runner can grow at its own pace without the risk of breaching loan agreements.
Base Runners in the tech space have everything going for them – except enough growth capital to reach home plate and a successful exit. Great management, impressive products and robust markets can take a company only so far. Today, venture debt growth capital is an increasingly attractive option to drive promising Base Runners across home plate.
Editor’s Note: Matt Eaton is an associate with NXT Capital Venture Finance in Boston. He has helped underwrite NXT’s investments in TradeKing, Digital Chocolate, Pinnacle Biologics, Estech and BoxTone, among others. Matt can be reached at 781.486.6607 or firstname.lastname@example.org.