Top Five Venture Debt Pitfalls for Startups
I love lists. My personal catnip is reading through an arbitrary ranking of anecdotes, experiences and pop culture. Blame social media, my short attention span…whatever. Just feed me listicles and don't bother me with long narratives.
For the past seven years, I've been working with startups at SVB and, consequently, have seen a few things. One of those “things” is startups seeking venture debt (my colleague wrote a fantastic overview on venture debt here if you need a primer), but doing so without understanding how much they want, why they want it, and how they'll use it.
Below are my Top Five Venture Debt Pitfalls for Startups:
1. Taking too much debt. This one is weird, right? How is more money bad? It boils down to two things:
I. When raising a future round, potential equity investors quickly do the math on how much fresh equity will go toward repaying loans, rather than growing the business. A balance sheet that's too levered might be just enough of a reason to pass if they're on the fence.
II. If things don't go well, and you spend all the equity and debt monies, and you're down to a couple months of runway, every dollar of loan repayment will inflate your burn. A big loan on the books in this scenario will feel like an anchor around your neck.
2. Taking debt too early. This begs the question: “How early is too early?” Generally, if you don't have operating history, or you can't provide monthly financial statements and regular business updates, or there's a lack of Board governance, it's too early. Usually in these circumstances, the only types of facilities you can get will have a steep cost, potentially cheaper than equity, but steep nonetheless.
3. Focusing strictly on price and loan size. Institutional track record matters. Besides, most venture debt facilities are modestly sized, so optimizing for price does not always equate to huge cash savings (and we covered the loan size issue above). Where I've seen companies put in challenging situations is when they've taken debt from providers that don't have a decades-long track record in supporting startups. Inevitably these players lose patience when it hits the fan.
4. No identified use for the money and saving for a “rainy day.” Taking venture debt---while a useful tool when used for momentum (extending runway, potentially increasing valuation and thus lowering dilution on next round)--can end up burdensome and “heavy” on a balance sheet if things aren't going well.
5. Waiting too long. If you find yourself in a surprising situation, with less than six months of cash and in a competitively compromised position, you probably need an equity bridge loan. Venture debt is best explored and implemented when a startup is well capitalized (following the Series A or B financing) and, as noted above, have a clear-cut use for the monies.
Views are my own and do not necessarily represent those of my employer.
Kaäre Wagner @Kaare_Wagner leads SVB's B2B & Fintech team in Los
Angeles, focusing on banking, debt financing and making impactful connections for entrepreneurs and their startups. Based in SVB's Santa Monica office, Kaäre (pronounced ‘Korey') works with some of the most disruptive and exciting early-stage consumer and enterprise companies in the area. He draws inspiration from the unique energy and optimism inherent in the founders he works with, and enjoys helping them realize their vision.
Joining Silicon Valley Bank in 2010, Kaäre previously served as a vice president in the Private Bank, and then Growth Software group, where he helped scale software companies backed by top-tier investors. Prior to joining SVB, he held various positions at Wells Fargo, including commercial relationship and business relationship manager. Kaäre holds a bachelor's degree from Northern Arizona University.
Outside of work, Kaäre spends weekends cleaning up his kids' spills, taking family trips to the park or beach, and sometimes sneaking in tennis or a run. He's also a proud advocate of SVB clients in our Wine Division; his current favorites being the Rivers-Marie Sonoma Coast Pinot Noir and for those especially warm LA days, the Liquid Farm Golden Slope Chardonnay.