Venture Debt: Rightsizing Your Venture Loan

Capital Advisors Group has been advising companies seeking to obtain venture debt for more than 18 years. Among the most common questions we get from new clients are “How much do you think we can borrow?” or, “We would like to borrow X. Do you think that is possible?” Clearly, the amounts companies may be able to borrow when seeking venture debt can be a big source of uncertainty. But understanding several factors that apply when considering how much you should borrow can help clear up the confusion. So, it’s important to start the process by asking a few key questions:

• How much cash does your company have on hand? (If you are burning cash, you will want at least 12 months).
• If venture backed, who are your investors? (VCs with experience in your market can be a great source of insight on how much you should borrow as well as referrals to appropriate venture debt lenders).
• If public, what is your market cap?
• If generating revenue, how much and what is your EBITDA and CAGR?
• Does your company recognize revenue on a contract/SaaS basis?
• For life sciences companies, is there a deep pipeline of assets? Is the company facing near-term regulatory risk or clinical trial results? Or are you getting ready to transition from clinical to commercial stage?

Answering these questions will help you determine the amount that is an appropriate market ask when pursuing debt financing. While some lenders may be willing to provide financing that might overleverage your company, you may find yourself in dire straits if the business doesn’t go according to plan. Uncertainties ranging from product development success or failure to hit revenue growth targets and profitability forecasts can impact your ability to service the debt. Therefore, a comprehensive, clear-eyed view of your current financial position and a realistic appraisal of your growth trajectory, product launch plan and/or revenue forecast are essential to determining an appropriate amount of debt.

Hundreds of Lenders to Choose From

Further complicating matters, there are hundreds of lenders in the market willing to lend to venture-backed, early revenue stage, or lower middle market companies. And each seeks to find a niche that will set itself apart from all the others. Whether it’s the loan structure, terms, or loan sizing, every lender has a “sweet spot” in terms of the types of deals they’re seeking. Venture banks tend to be somewhat generalist lenders across sectors. But non-bank funds can have very specific lending criteria:

• Some funds may lend only to SaaS companies and provide loan amounts that are multiples of ARR or lines of credit based on MRR.
• Others may focus solely on life sciences and tend to lend up to a specific fraction of current cash on hand.
• Other funds only lend to profitable companies and determine loan amounts as a multiple of EBITDA.
• Still others will lend to revenue generating but cash burning companies and base their loan amount on a combination of top-line revenue, annual growth, current cash and (possibly) the length of the path to profitability.
• And there is even an emerging set of lenders seeking deals that comply with an ESG mandate.

As the descriptions above reveal, navigating the venture debt market can be a somewhat dizzying experience, especially for companies committed to running a thorough process. But understanding the focus each lender brings to a prospective deal can help you determine the right group of lenders to approach. Lenders with experience in your industry and market will help you determine an appropriate size for your financing. Then, if you include multiple appropriate lenders in your search, you will be better able to optimize your loan terms.

Below are some benchmarks companies might use to consider loan sizing. (Disclaimer: These are very general benchmarks. The reality of debt financing is that every deal is unique, and each company presents to the market its own set of strengths and potential weaknesses which will tend to alter the borrowing capacity).

Life Sciences

Life sciences companies are unique in that they may take many years, even a decade or more, before they launch a commercial product. Therefore, the borrowing model is unique for these companies. Whether public or private, they should have a healthy market cap or strong investors, respectively, and have at least 12 months of remaining cash or plan to pursue an equity round concurrent with any debt raise. Lenders also prefer a deep pipeline of assets to avoid binary regulatory risk. In some cases, platform companies targeting multiple indications satisfy this requirement. Without hidden issues around IP/licensing or legal troubles, companies might consider 30%-50% of their current equity on hand as an appropriate borrowing range.

Tech and Other

As prior examples suggest, there is both art and science in determining appropriate borrowing amounts for revenue generating companies. There are also many options when it comes to loan structure. Still, if a company is generating revenue but still burning cash, strong investors/sponsors help tremendously.

For companies with a recurring revenue model, some lenders may provide 1-1.5x ARR as a cap of total debt the company assumes. Others may provide credit lines in the range of 4x-8x of MRR. Term loans for non-recurring revenue companies are even less formulaic. If the company is experiencing exponential growth, has top-tier investors, or has raised (and not yet burned) significant equity available debt will be much larger than ff a company is burning significant cash, short on cash or a long way from profitability.

How Much You Can Borrow vs. How Much You Should

Finally, it is important to note that how much a company can borrow is not necessarily how much a company should borrow. “Rightsizing” a loan is not just going to market with a reasonable ask but also considering an amount that is appropriate to adequately support the company’s growth without unreasonably restricting cash flows. Remember, you have to pay it back, with interest and additional upside to the lender. The bottom line is venture debt can be incredibly useful (and far less dilutive than equity) when used appropriately.