What is venture debt and how to find an alternative solution

Jonah Remz
Jonah Remz
Head of Finance
Posted on
June 27, 2023
min read
What is venture debt and how to find an alternative solution

Equity-diluting venture capital funding is the gold standard of SaaS startup funding, but it’s not always ideal for every scenario. If your startup has successfully made it through its first couple rounds of VC funding, you’ve probably started looking for other ways to supplement your cash flow.

Venture debt has emerged as a popular financing option for early-stage SaaS companies as a way to supplement traditional VC funding. It’s easy to acquire for companies that can’t secure conventional loans, and it’s typically offered by the same organizations that offer equity VC financing—making it easy to acquire if you already have a working relationship with them.

However, while venture debt financing can seem appealing at first glance, it comes with challenges and limitations and isn’t always the best option for every business. Keep reading to learn more about venture debt for startups, including what it’s good for, what it isn’t good for, and what other alternatives exist that may better suit your needs.

What is venture debt and how does it work?

Venture debt is a type of debt financing for early-stage, high-growth companies. It is designed for businesses that lack sufficient cash flow and a substantial financial history to qualify for conventional loans and is offered by specialized lenders willing to take on this increased risk. It is usually used in conjunction with normal venture capital. 

Although venture debt can take many forms, it usually has shorter terms and higher interest rates than conventional loans and is provided by organizations that are well-versed in working with startups and venture capital. 

But no matter the terms of the loan, the key defining feature of venture debt is that it’s targeted at high-risk, high-growth companies. 

What is the process for getting venture debt financing?

Startups can obtain venture debt loans from specialized lenders who understand the unique needs and growth trajectory of early-stage businesses. Typically, this means going to financial institutions that serve the startup market, like specialized banks, venture capital firms, and non-bank growth financing lenders

The process of securing venture debt is similar to other forms of debt financing and involves submitting an application and going through an evaluation phase. However, unlike conventional loan providers, venture debt providers tend to place greater emphasis on the startup's growth potential and underlying business model rather than relying on historical financials. 

What are the normal terms of a venture debt loan?

The duration and terms of venture loans can vary. While terms can range from several months to a few years, venture debt is typically considered a short-term funding solution. This allows companies to bridge gaps in their cash flow, address working capital needs, or seize growth opportunities without resorting to a full venture capital financing round.

In general, the typical venture debt loan may involve:

  • Providing a capital amount somewhere between 25% to 35% of the amount raised in your most recent venture capital equity round.
  • A repayment term of 3-4 years.
  • Interest rates of around 6% to 12%, with rates up to 15% also being fairly common.

How is venture debt different from conventional debt?

Venture debt differs from conventional debt in the following ways:

  • Shorter terms. Venture debt terms can be anywhere from 6 months to a couple of years but rarely extend beyond 5 years. 
  • Targets high-growth, early-stage companies. Like venture capital, venture debt lenders target borrowers with growth-focused business models. By contrast, conventional debt lenders may prioritize more stable companies with established cash flow. 
  • Higher interest rates. Venture debt often has interest rates of 10% or higher, while conventional business loans may hover around the 5% to 10% mark. Venture debt interest rates are higher due to the higher-risk nature of the loans.
  • VC-like requirements for approval. Like traditional venture capital, venture debt lenders typically look for high-potential businesses that demonstrate rapid growth, expansion, and previous equity financing rounds. Debt to equity ratio, satisfactory performance updates, and ability to meet certain growth or financial milestones are also heavily considered with venture debt. By contrast, conventional debt may require collateral, a track record of consistent growth, a good credit history, and other typical requirements.

What is venture debt typically used for?

SaaS startups often turn to venture debt to address specific short-term financial needs or to fund a project that’s immediately needed to boost growth. Here are some of the most popular ways venture debt is utilized: 

  • Extending runway. Venture debt can be used to extend runway and buy more time to achieve key milestones or secure additional funding.
  • Financing working capital. Venture debt can provide the necessary working capital to cover day-to-day operational expenses and sudden unexpected expenses, such as hiring, software, or travel expenses.
  • Equipment and technology investments. Sometimes growth requires investing in a key piece of expensive equipment or technology. Venture debt can be used to pay for these expenses without diluting equity.
  • Research and development. Venture debt can provide capital to advance product development, conduct market research, invest in intellectual property, or pay for other expenses to accelerate innovation and product development.
  • Sales and marketing expansion. Venture debt can be used to invest in marketing campaigns, hire sales teams, or expand into new markets during crucial times, such as a product launch or a pivot.

It's important to note that venture debt usually isn’t used as a replacement for equity-based venture capital funding. Most SaaS companies use venture debt to complement VC funding or to act as a bridge to cover key expenses in between funding rounds. 

To learn more about how startups utilize venture debt, check out this article

Types of venture debt financing

Venture debt can encompass many different debt-based financing options. However, in general, most venture debt financing lenders will be offering some version of one of the following three options.

A business line of credit

A business line of credit allows companies to access funds up to a predetermined limit, with the option to borrow the entire amount or only a portion of it as needed. You only pay interest on the portion you borrow, and you can borrow and pay back what you’ve borrowed on a timeline that works for you, with some limitations. Essentially, it’s like a credit card, but with a larger borrowing limit. 

Revolving credit lines like this are great for addressing short-term cash flow requirements, bridging temporary gaps, extending working capital, or managing unexpected expenses. They are particularly useful for startups that experience fluctuations in their cash flow due to seasonality or irregular revenue patterns. 

Convertible debt

Convertible debt is a type of short-term financing that has the potential to convert into equity at a later stage, typically during a subsequent equity financing round. Basically, instead of repaying normally, a portion of the loan gets repaid in equity—similar to how venture capital works.

This form of debt offers flexibility for both the borrower and the investor. Instead of requiring full repayment, the loan amount is structured to convert into equity on a specified date, which is called the maturity date. If the company successfully raises capital before the maturity date, the debt converts into equity, which allows the investor to participate in the upside potential.

Convertible debt often includes additional provisions, such as caps and discounts. This type of venture debt financing is beneficial for startups that anticipate significant growth but may not have the ability to repay the loan in the immediate future.

Growth capital term debt

Growth capital term loans are the most common form of venture debt financing. They are high-interest fixed-term loans that are repaid over the course of two to four years. In many cases, growth capital term loans have a six to 12-month interest-only (I/O) period where the lendee only pays toward their interest and not their principal.

The funds from growth capital term loans can be released in a lump sum or in installments, providing SaaS businesses with the option to access some cash upfront and additional amounts later.

Most lenders of growth capital term loans look at a company’s existing equity and expected future growth in assessing whether the company will be able to pay off the debt. These loans are usually meant to accelerate rapid growth rather than finance day-to-day operational expenses, but this isn’t a hard rule. 

The problem with venture debt for startups

While venture debt can be a great way to provide startups with additional capital to fuel growth, it’s not without its downsides. Here are some key issues associated with venture debt:

  • High interest rates and fees. To mitigate the extra risk of working with new, high-growth companies, venture debt involves higher interest rates and fees than conventional debt. Even if the loan is low interest, fees associated with origination, underwriting, and prepayment are typically higher than average.
  • Covenants and restrictions. Venture debt agreements typically come with covenants that impose certain financial and operational restrictions on the borrower. These covenants may include financial performance metrics, debt-to-equity ratios, or limitations on additional financing.
  • Potential dilution of equity. If you opt for a conversion loan or another option that involves paying your debt with equity, you risk the same dilution and loss of ownership as you would with traditional venture capital. 

How revenue-based financing for startups provides an alternative solution 

So what should you do if you want to avoid the negatives of venture debt financing, but also can’t or don’t want to go for traditional venture capital, conventional debt, or other popular options for startups?

One alternative is revenue-based financing

What is revenue-based financing?

Revenue-based financing, or RBF, is a growth financing option where capital is exchanged for a percentage of a company’s future revenue. It involves no dilution and no debt, only requires a few straightforward fees, and is easy and quick to access, even for businesses that have difficulty securing other funding options. 

How does revenue-based financing work?

Because revenue-based financing providers are investing in a company’s growth potential, approval and underwriting are based on a few simple pieces of criteria. RBF lenders are interested in companies that can show a track record of several months of consistent revenue and have the financial records to prove that they’ll be able to sustain or grow this revenue during the repayment period.

If a company is able to meet this criteria, it can receive an offer and access upfront funding within days, rather than the weeks or months it takes to access funding from venture capital or debt financing lenders. 

What is revenue-based financing typically used for? 

Revenue-based financing can be used in many of the same growth-oriented situations venture debt is used for. It can also be used to cover a variety of more routine expenses that venture debt is less suited for. Here are some of the most common uses of RBF.

  • Business growth. Like venture debt, RBF is often used to support business growth initiatives. Startups can use the funding to expand their operations, enter new markets, invest in research and development, or scale their sales and marketing efforts.
  • Marketing and sales expenses. RBF can provide the necessary capital to accelerate marketing and sales activities like increasing customer acquisition, launching new marketing campaigns, or hiring additional sales personnel.
  • Developing and launching new products. SaaS companies can use RBF to invest in product research, prototyping, production, and marketing of new products.
  • Working capital and operational expenses. RBF can be used to pay day-to-day operating expenses such as software, office rent, payroll, and cloud storage.
  • Extending runway. Like venture debt, RBF can be used to extend runway in between equity financing rounds or during times of unexpected cost increases. 

The benefits of revenue-based financing over venture debt

Here are some of the key advantages revenue-based financing offers over venture debt. 

  • Minimal credit requirements. While venture debt has fewer credit requirements than traditional debt financing, your credit profile is still taken into consideration. Revenue-based financing, on the other hand, doesn’t consider credit history at all and instead focuses on the company’s revenue generation potential.
  • No collateral is required. Unlike all forms of debt financing, revenue-based financing doesn’t require collateral, such as property or assets, as security for the funding. This means that businesses without collateral can still qualify, and founders don’t have to worry about losing equipment, real estate, or their life savings. 
  • Flexible repayment schedule. Instead of fixed monthly payments, RBF providers take a percentage of the business's revenue until a predetermined repayment cap is reached. This allows businesses to align repayments with their cash flow and reduces the risk of default during challenging periods. 
  • Scaleability. Since revenue-based financing terms are tied to your ARR, it can scale alongside your business. This means you can have smaller repayments during less successful periods and access more capital during growth periods. 
  • Quick access to funding. Unlike venture debt that can require weeks of back and forth to secure, revenue-based financing can be acquired within as little as a few days—so you can get the capital you need exactly when you need it.
  • Simplified application process. Since applying for RBF only requires the financial data on your revenue, the application and underwriting process is much more streamlined, quick, and simple than venture debt. 

To learn more about how applying and getting approved for RBF works, check out this guide for founders

Venture debt vs revenue-based financing: What’s the difference?

In summary, here is how venture debt and revenue-based financing differ. 

Venture debt financing 

Venture debt is usually used by early-stage companies with a high-growth trajectory who have had at least 1 round of venture capital funding. It involves taking on debt, and in some cases may involve giving up equity. It is often used for growth-oriented expenses, but can also be used for other expenses. Venture debt can take weeks or months to secure.

Revenue-based financing

Revenue-based financing can be used by any company with an established revenue record, which typically means the company must be generating revenue for at least a few months. Companies that are growing at a slower, more sustainable rate and have predictable revenue are more likely to be considered than super high-growth companies. The amount given is based on a company’s ARR, and repayment is taken as a percentage of each month’s revenue. It does not require losing equity or taking on debt.

RBF can be used for many different expenses but is most commonly used to supplement capital between funding rounds, fund new projects or initiatives, or take care of operating expenses. RBF can be acquired in a few days. 

Finding the right alternative solution for financing your business

If you need something to tide you over between VC funding rounds or to help you invest in a new expense or growth initiative, both venture debt and revenue-based financing are popular options. Revenue-based financing, however, comes with the added benefits of not requiring taking on debt or losing equity. It is also easier and quicker to acquire and can be used for a broader range of expenses. 

The right financing option for your business will depend on your specific funding needs, growth plans, and risk tolerance. No matter what option you choose, It’s important to assess your needs carefully and do your research on funding providers to ensure you work with a credible lender that has a history of working with SaaS businesses. You should also pay close attention to the terms and conditions of your financing agreement.

If you’re looking for an experienced revenue-based financing provider that offers funding as well as growth support, consider Capchase. We’ve helped hundreds of SaaS businesses secure the funding they need to grow, extend runway, and cover necessary expenses.

To check how much our funding solutions can help you extend your runway, check out our runway calculator