Technology startup companies looking for growth capital have two options: equity or debt. In this blog post, we’ll explore the traditional methods available to startups for obtaining growth capital including their pros and cons. We’ll also delve into a new solution that solves some of the challenges associated with the traditional equity and debt strategies.
Raising Capital: Equity versus Debt
To obtain additional funding for growth, companies can raise venture capital, which provides a startup with capital in exchange for equity and often board seats.
While equity is a critical component of any capital stack, it is dilutive. Eventually, as a company raises more and more venture capital, the ownership moves progressively out of the hands of the founders.
Additionally, after multiple rounds of investment, VCs will often not want a company to raise additional venture capital and dilute their own shares further.
To avoid dilution, these companies could seek to obtain a loan from a bank or a venture debt provider. While debt offers retainment of equity and control, the company must repay the lender with interest, regardless of the company’s level of success.
Traditional bank loans offer low interest rates, but can be problematic as the lender generally wants positive cash flow and a strong balance sheet with growth projections backed by historical success. Often, the company is trying to obtain the loan to achieve those exact same milestones. When banks do lend to growing tech companies, the loan amounts are often far smaller than what the company is looking for and have highly restrictive terms.
Banks have been trying to lend against “enterprise value” for years, but still traditionally only take into account tangible assets and ascribe zero value to the intellectual property, the real value of an enterprise. Lenders overlook or discount the value of IP when determining loan size and/or eligibility.
Then There’s Venture Debt
An alternative option to a conventional bank loan is venture debt. Venture debt providers understand the unique nature of early stage and/or venture capital-backed startups.
This can be attractive to companies that have successfully raised venture capital, but still do not have a sufficient history of positive cash flow to qualify for conventional loans.
Venture debt, however, is a high-cost option, charging both high interest rates and excessive fees as well as requiring dilutive warrants.
New Market Solution Avoids Traditional Pitfalls
There is an alternative that helps technology startups obtain the necessary funding to reach the next phase of growth at an inexpensive rate without giving up equity, while the debt provider obtains assurance the loan will be repaid in the event of default.
It’s an innovative alternative to venture debt that transfers the risk of lending to the insurance marketplace.
PIUS (Patent Insurance Underwriting Services) loans are backed by a proprietary insurance policy that facilitates larger loans with better terms, designed specifically for technology companies.
Backed by an “A”-rated carrier, this policy is based on the value of a company’s intangible assets (patents, trademarks, and trade secrets) as determined by the PIUS team.
How PIUS Loans Work Differently
A PIUS loan offsets the challenges of traditional venture debt and offers advantages to the borrower:
- It’s fully protected by a proprietary insurance policy, allowing for competitive financing terms with higher loan limits than what’s available in today’s traditional debt market.
- It significantly improves borrowing limits by insuring IP, often the most valuable asset for technology companies.
- An “A”-rated insurer assumes the risk associated with the loan, assuring the lender repayment in the event of the company’s default.
- It offers the flexibility to work with the company and the investors to determine the best terms for the company.
- The IP is still fully owned by the company, PIUS does not look to own or sell the IP.
Understand the Components: How to Qualify for a PIUS Loan
PIUS loan limits can be anywhere from $5 million to $25 million, with an interest-only period and amortization thereafter, at competitive bank interest rates.
Tech startups seeking this kind of funding must have a minimum of $5 million in gross revenue, have positive to slightly negative cash flow and have usually gone through a Series B funding or later.
No matter what route you take to obtain your additional funding, you should speak with an insurance broker who’s experienced with the venture capital space. We on the Woodruff Sawyer Private Equity and Transactional Risk team have been working with the VC community for over 25 years. The partnership we’ve forged with PIUS is just one of the innovative solutions we’ve created to help our technology clients.
For more information, contact:
Dan Berry, Partner, Woodruff Sawyer | 415.399.6473 | firstname.lastname@example.org