If you’ve been following my blog for a bit, you get how the money can flow, valuations are set, terms are decided, etc.  I tried to remain as impartial as possible.  Well, the table is turning and I am going to start putting my thoughts out there.  I’ll start by digging in to the venture debt market.

Raising capital from a lender is just inherently risky.  There is a reason huge venture backed companies that raise massive rounds never touch it.  Why risk the huge valuation of a company over a couple million dollars of debt?  It just doesn’t make sense.

That ISN’T to say that there aren’t significantly more opportunities to raise and use venture debt effectively.  First, getting a bank line from one of the venture banks is almost a no brainer.  Money is really cheap right now, they don’t put many restrictive covenants in place, and the warrant dilution is less that the options for a new college grad.  It is just a good way to provide a sensible amount of stretch capital for the unplanned, unknowns of the world.

Beyond that I think venture debt becomes segmented very quickly – every situation is truly case by case.  Using debt to fund topline growth is where I believe venture debt is best suited.  This means an established business, generating a reasonable amount of predictable revenue, with an end goal in mind.  If there isn’t a path to being cash flow positive, at which point you can repay the loan without impacting growth, venture debt just becomes a replacement for equity with a lot more risk.

It is easy to make those statements when you can always raise more equity are fair valuations.  Clearly that isn’t always the case, which is why each situation is unique.  If you are in the middle of a massive technical inflection point and pushing out the date of an equity raise by 6 months increases the valuation by an order of magnitude, do it!  Just do it with the full understanding that the equity will come in and refinance out the debt.

I’ve found the most common issue with debt is when companies are using debt as a short term band aide, and something doesn’t go exactly to plan.  Which is ALWAYS.  It just never is perfect in the real world.  Being caught with a pile of debt on your business, insufficient cash flows to support it, and a valuation that you are not prepared to sell for is a recipe for disaster.

There are many situations where it is a fantastic solution that fits all the needs of all parties involved.  The few rotten apples spoil the bunch for everyone else.