Dow Jones VentureSource reports that 661 US companies received $6.4 billion of equity infusions in the first quarter. That’s a 35% increase from the comparable period last year. Much of that investment came from VC’s but a meaningful amount came from corporations which participated in 10 of the largest fundings in the quarter. Renewable energy, healthcare and information tech companies were the largest sectors. In addition to the equity raised, US companies raised approximately $750 million of venture debt. Much of that capital comes from private funds and the data isn’t tracked publicly. With all of that capital sloshing around, do the venture debt funds represent a competitor to venture capitalists?
Competition for the hottest companies means that anyone with a checkbook is a competitor for a VC. Angels, corporations, banks and venture debt firms all represent very large checkbooks. As an aside, angels invest approximately the same amount as VC’s annually according to data tracked by Jeff Sohl at the University of New Hampshire. So how do entrepreneurs know when to use equity or debt?
Some real-life, candid opinions that I’ve heard…
VC: “I use venture debt when the company is no longer an attractive candidate for my equity but they still need cash.” (put some lipstick on that pig and teach it to say ‘hey sailor’)
West Coast Entrepreneur: “I want to borrow as much as I can so back up the truck and load me up.” (I’ll worry about paying it back later)
East Coast Entrepreneur: “I hate leverage. I have a 15 year mortgage on my house and I pay cash for my cars. Being debt-free feels great.” (If I don’t want dilution, I’ll get ‘customer financing.’)
I use the matching principle. Short term (a year or less) financing needs should be met with formula based lines of credit from a bank. There are some excellent banks that service the venture-backed market and you should pick one of them if you have a short-term financing need. Long term assets and equipment financing should be done with a term loan or a lease, generally 36 months in term.
Likewise, very long-term financing needs (5-7 years) are generally financed with equity. Even equity isn’t a permanent financing solution because limited partners expect their capital back at some point.
Intermediate financing needs should be evaluated to see if venture debt will fit. If a business needs capital today and expects future cash flows to be sufficient to service the debt you have an intermediate term financing need that is a candidate for venture debt. The benefit of the capital infusion today needs to be weighed against the future debt service. Debt feels great on day one when you get the capital…every day thereafter, it’s part of your burn rate.
Venture debt didn’t exist 20 years ago and today it’s a $3-4 Billion source of capital annually. In the next five years, it will grow to $10 Billion as the number of venture funds shrinks. We’ll undoubtedly compete with VC’s for the hottest deals but entrepreneurs will use the matching principle to get the financing mix correct.