Innovation takes ingenuity and capital. Much attention has been given to the increase in equity available for companies in Europe. However, given the rise in discussions around Venture Debt and the lack of data around the topic, we decided to explore the role of debt in the European venture ecosystem.
Even in a time of abundant cash, debt can be an attractive financing option for venture-backed companies looking for alternatives to equity financing. Debt comes with the need for repayment but by blending debt and equity, companies can form their optimum financing solutions.
There is no comprehensive data on the European market for Venture Debt. Silicon Valley Bank prepared an estimate market size based on a range of data sources and a top-down analysis. Fundraising based on publicly available data was used to estimate annual run rate for new commitments over time. This was supplemented with EIB lending data in the Venture Debt space based on public announcements, as well as Silicon Valley Bank's own lending activities based on internal data. To account for other active participants, the data was grossed up by c.15%. The estimate for 2020 was compared to the European Investment Bank ('EIB') research completed in 2019 which indicated that 5% of the financing in Europe came from Venture Debt, further validating our market size estimate. The data for 2010 is based on the BVCA Rise of Venture Debt report from 2012.
“In our situation, we view venture debt as a cost-effective component of our capital structure. Venture debt can be a very flexible, non-dilutive, way to extend your cash runway and time between equity rounds, which is particularly valuable in periods of high growth, to allow you to maximize your valuation between rounds.”
Debt financing can operate as a helpful non-dilutive supplement to equity in fuelling growth. Beyond helping us accelerate our rapid growth, debt financing can also be beneficial in bridging a gap between larger equity financing events.
VCs' & Founders' Familiarity with Venture Debt
Whichever debt financing option is most suitable for your company, timing is key. Earlier stage businesses will get the most attractive offers from lenders when they have just raised equity and therefore have cash and are less risky. As such, companies may want to explore debt finance when times are good, and they have a lot of cash runway as they will get better offers from lenders. Businesses should avoid waiting to approach lenders when cash is low or they are wanting a cash “bridge”, as lenders may then decline or charge a higher price due to the increased risk profile.
Companies should also check each term lender’s offer carefully and avoid restrictive items such as covenants set at a level the company is unlikely to achieve, or very high “success fees” payable at exit. Rather than comparing just headline interest rates, companies should compare all terms between competing debt providers to calculate an overall cost of capital which includes arrangement fees, early repayment fees, exit fees, non-utilisation fees etc.
Whichever debt structure you opt for, it’s vital to take references on lenders from your Board or advisors and choose a lender who will add value through useful connections (not just finance) and will be supportive over the long term through good times and bad.
Venture debt has proven an essential tool for Daye as we brought the manufacturing of our pain-relieving tampons in house. Venture capital is rarely an appropriate source of funding for hardware, design engineering and production expenses. Through venture debt, Daye got to enjoy the best of both worlds - venture capital to fuel growth, and venture debt to enable us to continuously invest in R&D projects that will pay off in the long-term. We wouldn't have been able to deliver on our promise for genuine product differentiation if we didn't have venture debt at our disposal.