Why should you be interested in this kind of funding?
The magic word is dilution. The entrepreneurs know that their companies’ shares are highly valuable. The shares that Venture Debt receives correspond only to a fraction of the loan (20%-30% of the loan), known as Equity Kicker.
Imagine a company with €10M pre-money valuation that is trying to raise €2M. Founders can finance through Venture Capital or Venture Debt.
Venture Capital: the founders will dilute up to 17%* and will give away political rights.
Venture Debt: the founders will dilute up to 5%** without giving away political rights.
Now imagine that in a few years the company increases its valuation up to €40M. If the company had been financed through VCs, the VC shares would value c. €6,8M. If the company had been financed through Venture Debt, the Venture Debt shares would value c.€2M, but also, the company would have paid back the €2M loan and its associated interests (c. €600k***). The total cost for the company & founders if funding was through Venture Debt amounts to c. €4,6M versus that of Venture Capital that amounts to c. €6,8M.
As you can see, there is a €2,2M difference. It corresponds to the savings that the founders keep in their pockets. Who would not keep €2,2M worth shares of their own company?
* The share that the VC would take will correspond to the new funding divided by the post-money valuation. In this case €2M/(€10M+€2M)=16,67%, approximately 17%
** The shares that the Venture Debt would take will correspond to the new funding divided by the post-money valuation. In this case, with a 25% Equity Kicker: 25%*€2M/(€10M+25%*€2M)=4,76%, approx 5%.
*** We are assuming a €2M loan with 10% interest rate, 12 months of grace period and 36 months amortization