There is a lot of excitement, glamour, and media coverage surrounding companies that land venture capital. But these days that’s tough to do. The industry database VentureDeal reports that VC funding shrank by about 40 percent in 2009 compared with the previous year. Talking with venture capitalists this past year, I discovered that an often ignored alternative to venture capital may be on the rise: private debt.
There are key differences between venture capital and private or venture debt that are important for business owners to understand. For instance, VC funding usually grants the funder a hefty equity stake in the company, while private debt is a loan and usually conveys only a very small equity stake. Also, VC funding tends to compel a company toward some type of exit within three to five years, usually an IPO, a merger, or an acquisition, while venture debt doesn’t come with the same pressure.
Business owners interested in private debt may be in luck. With the traditional bank-credit channels approving far fewer loans, some venture capital firms are stepping into the breach and starting new private-debt funds.
Launch Capital managing director Elon Boms says his two-year-old VC firm started a private debt fund last fall to capitalize on burgeoning opportunities to help businesses outside of technology that were blocked from obtaining traditional credit. Since its debut, Launch Capital Small Business has provided seed-stage funding to three companies: a small manufacturing firm, an after-school children’s program, and a “virtual” delivery-only dry cleaner. Launch’s private debt loans have a term of three years with a small possible grace period, yield market-rate interest for business loans, around 10 percent to 12 percent right now, and have a small equity component. “We’re seeing a wealth of opportunity to fund businesses that traditionally wouldn’t attract venture capital but today can’t attract bank capital,” he told me.
Private debt can also come into play when venture capital deals are getting done, says Eric Speer, who has 30 years of private-debt experience. Right now he’s the California-based head of transaction sourcing for Canadian finance company Wellington Financial.
Speer says most of the private-debt deals he’s been involved in were designed to lower the equity portion startups gave to their VCs. Instead of deals being all in VC, it would be some VC with private debt layered on top. So private debt is something to think about; it can help you hang on to a bigger ownership stake in the business you built.