Exchanging your equity for capital isn’t the only way to finance a startup. Lack of awareness about the wider debt market among entrepreneurs can lead towards traditional equity-based funding which can dilute control of your business very quickly. So for many founders, retaining as much ownership as possible is a pretty attractive prospect.
So it begs the question – are there ways to protect founders equity through alternative means of capital?
An often-overlooked but attractive source of funding for high-scale businesses at an early stage with good business models is growth capital. The purpose of this article is to unpack what this really means for young businesses achieving exponential growth and how venture debt can be appealing.
So what is growth capital?
Otherwise known as venture debt, this is an innovative credit line ranging from £250k to £20m+ aimed at serving young and fast-scaling businesses at pre-profit stage. These businesses are characterised by high revenue streams and innovative products driven by strong commitments towards R&D (Research and Development) investment. Businesses in this scenario have outgrown angel investors but not established enough to easily access traditional lending as they’re typically loss-making and lack tangible assets. They’re usually backed by Venture Capital (VC) firms or even family offices and usually experience a shortage of capital between various rounds of funding from their investors.
This continues to be a gap in the market that needs attention.
Consider some of the 13,000 or so fast-growing UK companies turning over £3m – £150m per year, facing a cash flow crunch. The viable solution can be a growth capital facility as it’s delivered in a matter of weeks so that businesses don’t have to wait until their next funding round from their financial backers, which can take several months. This enables founders and their management teams to capitalise on commercial opportunities as they arise.
What makes growth capital attractive?
One of the most appealing factors over traditional financing is it’s non-dilutive with fewer covenants – no board seats and/or voting rights. This means founders maintain their equity while making high-level decisions such as allocating capital how they see fit, hiring who they want for key roles, and many other commercial activities.
The most appealing factor over traditional equity financing is that it is non-dilutive with fewer covenants – no board seats and/or voting rights.
Another attractive factor would be the speed of funding. Covid-19’s impact left many VC-backed companies struggling for cash flow, and uncertainty over equity valuations. Growth capital lenders were quick to mitigate this by providing non-dilutive capital until trading normalised and valuations improved. By the same token, companies who flourished over this period used this facility as a way to execute acquisitions of competitors and grow their market share in the process.
It’s also worth pointing out, a company can be on track to breaking-even or even trade profitably through a venture debt facility, minimising reliance on investors over time.
What makes a good case for growth capital?
Specialist lenders focused on innovative start-ups typically target companies that have recurring sales models with established products or services and can demonstrate scalability in the long term. A good example would be borrowers with an established track record of repeatable revenue operating subscription based business models (e.g. SaaS) with low customer churn and an ability to upsell services to existing customers.
Lenders in this space can take a view on current and expected performance in future, as opposed to historical financial performance unlike a high street lender, for instance.
A few good examples of a scaling businesses include:
- those building a market share in an emerging market and/or disrupting an established market.
- recurring revenue stream and demonstrate the ability to keep up the trend in future. This is an attribute that gives lenders visibility of a start-up’s future ability to service debt.
- high gross margins which is often an indicator that a company delivers high value-added services to customers.
- effective cost control practices. Grip on cash flow is a good reflection on management teams which can only impress lenders.
Growth capital continues to be an evolving product focused on young and typically VC-backed companies at a pre-profit stage but with strong recurring revenue models. Lending in this space is very much relationship driven — since the nature of this debt is complementary to VCs and family offices. So it’s key that entrepreneurs are aware of its significance early on. The size and structure that a growth lender provides should be aligned with the needs and strategy of a business. As the saying goes: you’re only as good as the company you keep. That’s to say it’s crucial to have a partnership-focused lender that values being flexible and playing a long-term game, both with your company and your investors.
Would you like to know more?
Shoots of spring and confidence are emerging as we move further into 2022, but growth plans in this environment need to remain flexible. Think of us as your strategic funding manager that you can call upon to help execute your next commercial milestone. If you would like to discuss your commercial plans in more detail, we’d love to hear from you. Please email firstname.lastname@example.org or let’s talk to discuss further.