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Common concerns about venture debt warrants alleviated

Common concerns about venture debt warrants alleviated

Thinking about a venture debt product to extend your cash runway and to get you to the next funding round, but worried about venture debt warrants?

It’s natural you’re concerned about making the right decision about financing your tech business. And what will happen if you make the wrong choice.

You don’t want the terms of your finance facility to restrict your company’s growth plans. Or for your capital to come with considerable cost.

Therefore, if you’re unfamiliar with the term ‘venture debt warrants’, I’m going to explain what they are and how they benefit both borrower and lender alike.

Venture Debt Warrants

 

What is a venture debt warrant?

A venture debt warrant is similar to a stock option. It gives the holder the right to buy shares in a company in the future at an agreed ‘strike’ price.

To put it another way, let’s say your company takes out a £1m venture debt loan with a 5% warrant coverage. Here, you give your lender the option to buy £50,000 in shares at a price agreed on the contract date.

 

How much do venture debt lenders expect to take in warrants?

In a typical venture debt agreement, a private debt fund asks for warrants over equity between 5% and 15% of the value of the loan.

 

Why do private debt funds include warrants in venture debt deals?

In the early years, fast-growing tech businesses typically burn cash and take time to turn a profit. For this reason, they’re often considered too risky to attract traditional debt finance.

Warrants give private debt funds leverage and an incentive to take on the risk because they offer higher returns at minimal cost.

 

What happens when a private debt fund exercises its warrants?

If we refer to the earlier example, let’s say your company’s share value has increased by 50% and you decide to maximise profit with an exit strategy. Perhaps you plan to IPO or to exit via acquisition. Your venture debt lender can use its warrants to buy and sell £50,000 of shares. Because they’re now worth £75,000, they yield it an ‘equity kicker’.

 

What are the advantages of debt warrants over covenants?

First off, warrants are easy and inexpensive to set up.

Beyond that, they give the private debt fund (holder) the right, without obligation to sell shares at a set price, before predetermined expiry dates.

What’s more they, they provide the lender with the opportunity to share the upside in the company valuation and mitigate any perceived risk in the deal

In comparison to Cash or EBITDA covenants, they don’t impede your growth or restrict your deployment of capital.

 

So it all adds up to this

Venture debt warrants make providing venture debt finance a risk worth taking for private debt funders.

And they don’t cost much to set up.

As a result, for the borrower, warrants make debt accessible and the cost of capital significantly cheaper than other options such as 100% equity.

What could be more important?

 

And finally

Different debt funds use different measures to calculate warrants. Because money is involved, the measures for calculating warrants can make a material difference to your company when you become a unicorn.

For a win-win venture debt deal negotiation (one with a mutually acceptable outcome) it pays to talk to an expert venture debt advisor.

So drop me a line, and we’ll set up a time to chat.