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Looking Beyond Equity: The Role of Venture Debt and Growth Capital for the Innovation Ecosystem

  • 5 mins
  • Article

Technology has been changing everyday life for decades – from the telegraph and telephone to personal computers and the internet to smartphones and social media platforms and so much more. The tech sector is hardly pumping the brakes, however, as startups and scaleups continue exploring advancements in AI, quantum computing and cybersecurity, among others.

Of course, disruptive innovations are not limited to the tech sector. In the life science and healthcare sector, emerging technologies are transforming patient care. For example, telehealth is improving access to practitioners and biopharma research is spurring development of new therapies and medical devices.

Yet, with a fundraising environment that’s been more challenging recently – companies are looking for new funding strategies. That’s where venture debt and growth capital can add value when used strategically.

Debt Without Dilution: The Strategy of Putting Venture Debt to Work

Designed specifically for institutionally-backed, high-growth companies – debt financing complements equity financing nicely, says Dave Sabow, Head of Innovation Banking at HSBC. “This type of debt financing can be a powerful tool for venture-backed private companies as well as public companies still in a cash burn mode,” he explains. Typically, more flexible and lower in cost compared to equity financing, venture debt can also minimize dilution. “This approach can be very efficient in augmenting a company’s capital structure and, when used at the right time in the growth trajectory, incredibly valuable.”

Use cases for venture debt have evolved over time. At one time, this tool was used as a strategy either in parallel to or on the heels of a fundraising effort to extend the runway. While venture debt is still a good strategy for that – today, it is also being used to help businesses capitalize on growth opportunities. For instance, venture debt can be used to:

  • Minimize dilution ahead of a key valuation inflection point. In this case, venture debt provides the runway a company might need on either side of a catalyst – allowing them to either pivot if the outcome is negative or gain time to negotiate a partnership or the next round of capital if it’s positive.
  • Augment a growth strategy whether that’s entering new markets, developing a new product or bringing a new product to market.
  • Fund an acquisition. “This can be especially attractive in biotech,” Dave says. “That’s because venture debt helps companies de-risk their portfolio through different mechanisms.”

It’s important to be open-minded about all different financing options – especially today, where the equity market has only partially recovered. For us, venture debt is an essential tool to have in the mix.

Chen Yu | Founder and Managing Director of TCGX

Balancing Act: When to Add Venture Debt to Your Toolkit

“Given the volatility we’ve seen over the last 24 months, it’s no surprise there’s a lot of demand for venture debt,” says Dave. “But like anything, there can always be too much of a good thing.”

Analyzing the role venture debt plays in the overall capital stack is vital. Not every company, regardless of how much equity has been raised, is a good candidate for venture debt. It’s important to understand the value of the dilution that’s prevented by using the instrument – but also avoid becoming over-leveraged, which can potentially block access to additional equity capital. This type of dilution analysis is critical for giving companies good advice around when to use venture debt and, just as importantly, when not to. It’s a balancing act – and that’s where experience matters a lot.

How to Determine if Venture Debt Right for You

“Our view is that having some non-dilutive financing on hand for when a need arises is just good corporate housekeeping,” says Dave. “Still, every situation is different, and you need a partner who understands the nuances of how venture debt functions under a variety of different outcomes.”

Chen agrees, noting that, like many industries, biotech is not a straight road. “There are a lot of potholes – and unless we have the right partner on our side, someone we can trust to react appropriately to every bump in the road we hit, I’m not sure venture debt would be worth the risk.”

The Bottom Line: With an experienced partner on your side, it makes sense to start thinking about how debt can play a role in your capital structure sooner rather than later.

HSBC Innovation Banking

Find out how HSBC Innovation Banking can help fuel your business’ growth journey.

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