Is borrowing capital the same as borrowing time?

With a much higher hurdle to raise venture capital , cash-constrained startups are increasingly turning to debt financing. Does this provide a temporary bridge to a better financial position, or is it merely prolonging a financial dead-end?

🤝 Venture Capital: VC funding significantly declined in 2023. ​​In the US Fintech sector alone, funding dropped by 38.8% compared to 2022 and by 67.5% compared to 2021. Meanwhile the US venture debt market is expected to rebound to $14–16B, a 25% increase from 2023, after increasing from $8.1Bin 2013 to $35.5B in 2022. 2023 was marked by major turmoil with SVB’s collapse, rising interest rates, a decrease in IPOs, and a slowdown in M&A.

🤌 Venture Debt: it is increasingly popular with startups looking to raise capital without diluting their equity ownership. Its share rose from 10% in 2017 to 14% in 2022 in the overall venture funding market. However, despite its covenant-light nature, venture debt principal must eventually be repaid (either amortized or as a balloon at maturity), and startups should be prepared to deliver strong revenue growth and robust margins to meet coverage ratios along the way. In other words, leverage only works well when growth already outpaces the cost of capital, but the downside is amplified.

🫰 Non-Dilutive Financing: this alternative private debt option encompasses two primary forms: revenue-based financing (capital raised and repaid as a % of revenue) and term loans. With venture capital rounds becoming smaller, more startups are supplementing their funding with non-dilutive capital, thus preserving their equity. But it is not without risk on both sides. For private credit providers, the abundance of capital has vastly increased competition for deals while fewer companies qualify as good credit to underwrite. For startups, maintaining revenue growth well in excess of the cost of capital is crucial to service these loans, and failure to do so can quickly worsen their financial health.

🙌 Structured growth equity: when a venture scale outcome is out of reach but the business has demonstrated product market fit (PMF), structured growth equity emerges as a viable financing solution. Instead of loading the business with debt, which is fraught with repayment risk, existing investors and managers team up with a new partner that injects fresh capital and re-aligns ownership to re-ignite growth through collaborative value creation. This approach can be structured as a majority or minority stake depending on the situation, but preserves significant upside for founders. It aims to improve operations and address existing gaps, guiding the business towards positive cash flows without the burdens of debt servicing and principal repayment.

In short: startups can use a mix of financing options to support their needs and find the best arrangement based on cost of capital, availability of funds, and anticipated returns. With VC funding temporarily less accessible, and often not a fit for low-to-moderate growth ventures, founders should carefully consider funding options. They should not merely be seen as a temporary relief but as a part of a thoughtful long-term financial planning to grow sustainably, not on borrowed time.