Growth debt is a form of business financing that involves borrowing funds from specialised lenders, typically dedicated growth debt firms. This type of debt is specifically tailored for startups and high-growth companies, offering an alternative to both traditional bank loans and equity financing. Unlike traditional debt, growth debt is designed around the specific needs of a fast-growing startup and is often structured to align with these unique features.
It is a financial tool designed to fuel the expansion of successful startups, allowing them to scale operations, enter new markets, invest in research and development, complete acquisitions or even get acquired. However, it’s crucial to note that only a small percentage of European tech businesses, typically ranging from 2-5%, are deemed eligible for this type of debt. The stringent criteria emphasise the need for a proven revenue-generating business model and growth potential.
So when is a startup a good candidate for growth debt?
- Bridge Financing, to add extra funding before an exit: In situations where there is a gap between signature and completion of an exit, growth debt can serve as bridge financing. This ensures that the company has the necessary funds to continue operations and meet its strategic objectives while awaiting the key exit event. Companies and their management can maintain the negotiating power with more cash on their balance sheet.
- Extending Runway: Growth debt can be an excellent option for startups looking to extend their runway between equity financing rounds. This ensures that the company has sufficient capital to reach the next milestone and meet its strategic objectives while awaiting the next equity infusion while limiting the immediate dilution of existing/new shareholders.
- Milestone Financing, to avoid dilution: When a startup achieves a significant milestone but wants to avoid raising equity at a potentially lower valuation, growth debt can be an attractive option. It allows the company to secure additional funds without renegotiating valuation terms. In the current context, with tumbling valuations, growth debt is a viable option to consider.
- Working Capital Needs or Equipment Financing, to avoid raising equity for operational costs: Startups often face working capital challenges, especially during periods of rapid growth. Growth debt can be used to finance working capital needs, such as inventory, accounts receivable, or other operational expenses. In some instances for deep tech businesses growth debt can be used to finance equipment and initial plant fittings.
- Capital Efficiency, to separate certain expenses from others: Growth debt allows startups to leverage their existing equity capital more efficiently. By using debt for certain purposes, companies can manage their capital structure effectively, avoiding unnecessary dilution and maximizing returns for existing shareholders.
- Proven Revenue Model, combined with High Growth: Growth debt is more suitable for startups with a proven revenue model and a clear path to profitability. Lenders assess the company’s financial health and ability to meet debt obligations based on its performance metrics. Growth is an important factor, as the name “Growth debt” implies. This sort of financing helps accelerate revenue increase to maximize equity value.
- A Sophisticated Strategic Tool for Sophisticated Companies: Growth debt is a strategic financing tool that can be particularly beneficial for startups facing specific shareholder syndicate challenges or seeking to optimize their capital structure. Most Growth debt financing initiatives come from board members and venture capitalists investors, who usually are familiar with this financing tool. It is key for companies to have a very solid CFO and financial functions to be able to keep up with the high standards of reporting needs of the growth lenders.
Knowing when to raise growth debt is key and this involves careful consideration of the company’s stage, funding needs, and strategic goals both from the lender and company Founder. When used judiciously, growth debt can complement equity financing, providing startups with the flexibility and financial resources necessary for sustained growth.
