In the lead-up to the first-ever Growth Finance Awards, we’re taking a look at some of the lesser-known growth financing options that support UK SMEs.

One of the most important (and lesser known) of these is venture debt, which we think plays an incredibly important role for small businesses.

What is venture debt?

Imagine that a growing SME needs more capital before another equity round in the future. It needs cash in the short term but is also reluctant to sign away more equity ahead of the raise.

A loan would suit the owner better, but as a fast-growing business with limited cash and few assets it looks risky to lenders. How can it be relied upon to pay down a loan if it is ploughing all its funds into growing quickly?

Venture debt solves that problem by including a late repayment date (helping the borrower) and warrants/equity purchase options (to incentivize the lender).

And because they are lending to SMEs, venture debt providers try to offer more than just finance by taking an active, hands-on approach with their partners.

In the UK, venture debt is offered by lenders such as Silicon Valley Bank, Columbia Lake Partners, Finstock Capital, Shawbrook Bank, Kreos Capital, Boost & Co and Barclays.

Last year Shawbrook Bank set out to lend £100 million in venture debt loans over the new three years. William Chappel, who is heading up the team, says: “We understand how debt finance can play a crucial role in helping entrepreneurs, and the investors behind them, successfully take their businesses on to the next stage of their development.”

Why do SMEs use it?

SMEs might use venture debt to ‘lengthen the runway’ until their next planned equity round. Or they might like to secure it as a sort of insurance policy to cover unexpected cash demands or equipment purchases.

It tends to carry a lower cost of capital than straight equity funding. One case study published by growth debt providers Boost & Co, who lent £3m to a software firm in 2015, states that the debt worked out up to 3.5 times cheaper after the business was sold in 2018 than the equivalent amount of equity.

Entrepreneurs’ verdicts

Several of the businesses that we surveyed for our 100 Stories of Growth campaign have used venture debt as part of their funding mix.

Education technology firm Firefly used £3 million from Silicon Valley Bank to refinance debt from high street banks. Co-founder Simon Hay says that the bank “understands how VC-backed businesses work and is very clear on what a software-as-a-service business does.”

The founder of childcare company Koru Kids, Rachel Carrell, also used venture debt and believes it  is “much misunderstood”.

However, Melissa Morris, founder and CEO of NHS recruitment firm Lantum, warns that venture debt can include covenants that are costly if breached.

Fixing the venture debt gap

Since alternative finance took off a few years ago, with platforms like Funding Circle and Crowdcube, it has never been easier for a new business to raise capital. But the UK still faces a problem with scaling up those businesses into their next stage of growth.

As Sherry Coutu CBE, a serial entrepreneur and angel investor, noted in an industry report: “The problem now is not the quantity of entrepreneurial activity, but the ability to turn that activity into high-growth scale-ups”.

Venture debt is still less common in the UK than in the US. A 2015 Barclays report (the most recent available study) wrote that 20% of US venture capital-backed firms had used venture debt at some point, while for the UK that figure is just 8.4%.

Venture debt has an important role to play because it can help businesses scale up by offering them more capital between equity rounds. And not only that, but the data suggests that companies which use it tend to raise more equity in the future than those which don’t.

At Intelligent Partnership, we think SMEs should be better educated about venture debt and how useful it can be in helping them grow.

That’s why we are pleased to recognise the Venture Debt Provider of the Year at the inaugural Growth Finance Awards this year, to celebrate how important lenders are for small businesses.

Guy Tolhurst, managing director of Intelligent Partnership, commented on the mission of the newly-introduced awards:

“The UK’s SME community has embraced all forms of growth finance to excel and expand, but its impact is rarely recognised. That’s why we’re celebrating the providers and champions of growth finance that are contributing ‘more than finance’ to help businesses scale to even greater heights.”