We all know the story – it is incredibly cheaper to start a web-based business versus 5 years ago with the rise of open source software and commodity servers. However, while getting started with thousands of users is cheap, scaling to significant numbers will require some dollars. The good news for you and for venture investors is that your buck can go alot further today versus yesterday not only because of the commoditization of infrastructure but also because the venture debt market is alive and kicking. In the last six months, we have augmented some of our existing venture financing with venture debt as the market has become quite competitive which means pricing and terms are getting more attractive for all of us. In addition, while most associate venture debt with investments in companies with core technology, more and more venture debt firms are back and willing to offer capital to earlier stage web-based companies with no financial covenants and MAC (material adverse change) clauses. Of course the more flexibility you have with respect to uses of cash means that pricing will go up. All I can say is when evaluating your company’s cash needs and potential runway, looking at the venture debt market is not a bad idea.
There is also another market metric that is driving a renewed interest in web-based companies for these lenders- they are getting funded by VCs (venture debt lenders mostly like to do deals with strong financial sponsors which increases their likelihood of getting paid back) and these startups are better able to manage their burn rates reducing risk and offering lots of upside. Sure, while some of these venture debt firms recognize that web-based businesses may not have as much hard and true intellectual property, the fact that they are more capital efficient and can scale more rapidly means they can also generate pretty nice returns from the warrant portion of their deal. Getting in earlier also allows these venture debt firms to buy more of the company from a warrant perspective than getting in on later rounds. The trick for entrepreneurs is to look at bringing on debt concurrent or soon after your close of equity financing.
All is not rosy as there are some potential and hazardous downsides to this model. If you burn through your cash and can’t make the monthly principal and interest payments, your lender can take over your company as their debt is usually secured against your company and intellectual property. Trust me, a number of companies got burned with this during the Internet boom when their businesses were based on wildly inflated revenue projections and unilimited capital resources. Just when you needed another month or two to sign that strategic deal, the venture debt guys would come in and pull the rug from under you. Granted it is not that bad as your lenders are your partners and will negotiate with you, but at the end of the day, if they see their ability to get paid in significant jeopardy, they will do what they have to do to recoup as much value as possible. For some investors and entrepreneurs, this risk may not be worth the dollars. For others who are confident in their execution and ability to raise another round, there is no better way to stretch your dollars in the company and create more value with minimal dilution. So the next time you hear the word "debt," don’t be scared and keep an open mind as you may be able to stretch your resources further and achieve some additional critical milestones driving increased value in your business. The interest in web-based businesses is there and the competitive market means that pricing and terms are pretty attractive now.