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Distinguish Between Venture Debt and Venture Capital

Posted by AmyLewis on January 23, 2012 in E-Business, E-Commerce with No Comments

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English: LBBW Venture Capital GmbH - Investmen...

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If you are an entrepreneur, you might often get confused about when to raise venture capital as against venture debt. This is because these two words have very thin
margin of convergence which raises the misconceptions in the first place. The basic difference between venture debt and venture capital is that the debt you have taken must be repaid. Venture capitalists are also very much interested in getting back their capital along with a profit. Most of the times distinction between the repayment of venture debt and the liquidity needs of venture capital blurs due to some current market dynamics. To most skeptics think that managing debt and repaying them back in a venture debt is a lot different from a venture capitalist hoping to get their money back. Here are some points that will help you better to understand the difference and similarities between venture debt and venture capital.

  • Venture debt usually has a straight period of time where the emerging growth company pays just the interest rate that is required on the debt. Theoretically the tech company begins making the payment on the principal at the end of this interest-only period. It has been noticed recently that most companies are making aggressive negotiations regarding extending of their interest-only period. This has been done by sometimes even refinancing the loan with another lender. If the company suffers a loss ultimately then the last lender who has the interest only debt is the one who suffers loss. Usually an unpaid debt is a semi-permanent part of the balance sheet of a company.
  • When venture capitalists are raising a new fund, they would, in all probability require liquidity events. In case the company gains success at a slower pace than was planned, the venture capitalist might want to do a dividend recap in order to get liquidity. The tech company usually declares a dividend and pays cash out to investors. Usually the source of these funds for the dividends is venture debt. When dividends are paid, equity is not anymore the permanent capital that it initially appeared to be.

The question of concern here is that if the line between debt and equity is so thinned, how an entrepreneur will be able to find out the right strategy for his business. Usually equity should be raised when you would require a financing for more than 4 years and when the flow of cash is highly volatile. You can consider other debt options which are less dilutive when your business expects future cash flows or even liquidity events in a span of 2 or 3 years. you should also see to it that the debt service payments is not more than 30% of the burn rates if future equity investors want to use their cash to grow their business.