Venture debt can be an attractive and flexible financing option to drive startup growth, in addition to venture capital investment. Discover what it is and find out about the first regional fund focused on this instrument.
Access more equity or debt? This is the question of several private companies in Latin America and the Caribbean (LAC) when they face the growth dilemma. However, many of the tech-based startups, also known as startups, cannot afford to ask themselves this question. That ‘s because, in addition to the risks inherent to its innovative nature, the startups often have limited access in terms of types and sources of funding. Having a few tangible assets, they do not have access to traditional bank loans, for example.
Access to financing is part of the mix of factors that means that approximately 70% of startups in the region do not survive.
A typical instrument that is becoming increasingly available for Latin American startups is an investment by venture capital funds in exchange for equity participation. In addition to capital, these funds also provide mentoring and strategic business support. The venture capital industry has shown steady progress since the 2000s in LAC. Investments reached the US $ 1.9 billion in 2018, almost double that of the previous year; and between January and July 2019, investments already reached more than the US $ 2 billion.
However, venture capital investment requires a valuation of the companies, a reduction in the percentage of ownership of the founders, and is not always sufficient to finance the growth of the company.
After rounds of venture capital financing, founders sometimes only maintain 10-30% ownership of their companies, just when they reach a critical level of maturity. Also, the influence of outside investors on the governance and culture of the company, as well as the pressure for short-term earnings, can often harm the healthy growth of the company.
So how do you continue to finance the growth of startups? It is here that a lesser-known instrument called venture debt appears, which is more mature ecosystems and markets are used as a complement to capital rounds to finance the growth and needs of new companies without causing their founders to lose part of the property. of the company.
What is venture debt about?
Venture debt is a debt that is not convertible into equity or shares (that is, it has to be paid in money), for startups that (1) are backed by venture capital funds, (2) have recurring accounts receivable, and (3) do not they have collateral or cash generation guarantees to obtain traditional debt. It is used when founders want to avoid diluting company ownership, but at the same time seek more flexible access to equipment purchases or financing for growth.
When properly structured, the debt venture can be a convenient and attractive option funding. It is generally less expensive than venture capital or entrepreneurial or mezzanine debt, and that contrast of these two instruments is a senior debt, which has payment priority over other instruments if the company faces a situation bankruptcy. It is attractive since the founders and investors do not dilute their participation in the company; nor does it require participation in startup governance, since venture debt is a product of non-capital debt (which does imply ownership participation and governance), and this is precisely why the due diligence process is less exhaustive than that of raising capital.
In other words, in the case of venture capital funds, the investor becomes a partner of the startup, which implies participation in the government of the company. In venture debt, the investor simply provides debt to new companies. In the United States, the best-known provider of venture debt is Silicon Valley Bank. In the entire Latin American region, only one fund is known that provides venture debt exclusively for Brazilian startups, managed by SP Ventures.
In a way, venture debt loans are equivalent to microcredit in terms of the methodology used. Loan officers tailor debt based on tech startups’ revenue streams, their term needs, and often do not require a traditional type of collateral to back loans. The technology is also used to collect repayment data from startups as they become clients – venture debt lenders closely monitor the company’s ability to repay the loan, adapting terms as necessary.
First fund for startups in LAC
The debt venture can be a beneficial product for the entrepreneurial ecosystem in Latin America and the Caribbean (LAC), taking advantage of a recent boom in the growth of startups technology-based are innovating with products and services. We estimate that there is an untapped market of approximately US $ 540 million for this product in the region.
The IDB Lab, the IDB group’s innovation laboratory, has approved the US $ 5 million to support the first startup debt venture fund focused on LAC. This new fund will be launched in the first half of 2020 and will be managed by a consortium between the companies IVO Capital of Mexico and Triaxis Capital of Brazil. The venture debt offering is expected to allow startups in the region to grow with the right capital structure and realize their potential for social and environmental impact.
With this fund, it is expected not only to prove the importance and usefulness of venture debt in the region, but also to help startups to enhance their growth, and that these, in turn, provide greater access to innovative services and products (health, education, finance, etc.) to society, especially low-income populations.