Return profile of Venture debt

Comparison of returns of Venture debt and Venture capital. When is it a good time to co-invest?

Author: Lucas de la Vega for Medium.

Venture Capital often co-invest with other similar equity funds to share risk in a transaction. This analysis will show how does Venture debt perform as a co-investor compared to Venture Capital.

We assume that the Venture Capital fund will not able to leverage the terms and conditions of the transaction as seen in this post.

We will divide the analysis in three parts following the classic distribution of returns of a Venture Capital: (i) Negative or no return transactions, (ii) Mild return transactions and (iii) Highly profitable deals.

Zero or negative return companies

Up to one third of the transactions of a Venture Capital firm are expected to have no returns at all, these transactions will have a negative IRR.

Negative returns tend to happen more often in small and aggressive deals where using Venture debt is not a better idea than sharing the ticket with another Venture Capital firm.

From an investor perspective, interest may drain resources from the company (we will assume that the company has certain cash restrictions). In addition, the debt itself may act as a liquidity preference at the time of exit.

IRR on Shares=-13%; Equity Kicker= 25%; i=10%; Maturity: 3y
IRR on Shares=-13%; Equity Kicker= 25%; i=10%; Maturity: 3y

This kind of transaction will only make sense as a last resort willing to extend the runway while financing an ongoing exit strategy.

However, this kind of deal structure is improbable from a Venture debt perspective given the high risk of default.

When building a portfolio none of the investments are performed thinking on making negative returns. Risk should be adjusted to the potential reward of the deal. In that sense, Venture debt should be used in the less volatile side of a Venture Capital portfolio.

In line with the aforementioned risk strategy, PitchBookPitchBook.

PitchBook is the leading data software provider for professionals in VC, PE and M&A.

3.4K FollowersFollow has proven that companies raising lower amounts of money at Seed are less likely to close a Series A increasing the risk of the transaction. For large Seed rounds Venture debt could be used as a top-up increasing the odds of being successful.

Mild performance companies

Another relevant part of a Venture Capital portfolio is composed by mild performance companies (1–1,5x). There are two possible outcomes based on time to exit and return on the shares.

IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y
IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y

Short and mid-term outcome is similar from Venture debt to Venture Capital co-investment.

You might see from the chart (left), that the loan amortization increases the ramp-up repayment and making less attractive a Venture debt.

However, Venture Capital are long term investors. Time to exit is generally above 5 years and for some companies could last up to 10 years.

Given the limited upside on the shares of Venture debt compared to Venture Capital. The longer you may hold a position the more attractive a Venture debt will became for current shareholders that will benefit from a more important upside (see below).

IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y
IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y

Outliers and Venture debt

Returns on Venture Capital follow a pareto law distribution where the outliers make c.80% of the reward of the fund.

This is Venture debt becomes a powerful tool for funds. Co-investing with another Venture Capital instead of a Venture debt will lead to more dilution, giving back some political rights and less room for future follow-on tickets.

IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y
IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y

Even in the short term, Venture debt is able to generate important savings.

The robust return on shares and the limited upside for Venture debt is the ideal situation for a debt co-investment.

Savings are exponential if we look on the long run. The difference between the 9.0x multiple done by a Venture Capital and a 3.55x generated by the Venture debt is in the pocket of current shareholders.

IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y
IRR on Shares=8%; Equity Kicker= 25%; i=10%; Maturity: 3y

From all the above, I would like to underline some key takeaways:

  1. For very early stage ergo higher possibility of write-offs. Venture debt should only be considered in middle and big size rounds were the company increases its possibilities or reaching a future round.
  2. Venture debt should be considered on long term investments and potentially big investments. In the mid-to-short term Venture debt is not competitive to capital give the ramp-up of amortizations.
  3. As a Venture Capital you should be keen on sharing your good-to-great opportunities with you Venture debt lenders in order to retain the upside of the transaction. Venture debt firms are able to provide bridge-to-round tickets once the Venture Capital has trimmed its portfolio.
Retain the upside by giving up some downside protection
Retain the upside by giving up some downside protection

Maintaining upside and giving up on the downside

In a few words, Venture debt is a trade-off different optionality. While onboarding a Venture debt you are keeping a wider upside on the business while increasing the downside risk. This is probably aligned with the Venture Capital state of mind, no risk, no glory.


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