Are Aussie’s conservative towards venture debt? Is it justified?

I’ve been in Australia for just over eighteen months now (having relocated from the UK for those who don’t know), and in this time I have started to notice cultural differences and norms with respect to venture debt.

Before arriving, I would have assumed that the long-distanced cousin of the Brit would view financial products in a similar way, in fact being more laid back, open and willing to try new things would actually lead to strong demand. Consumer debt is a very well-trodden path as is leverage in Private Equity.

I’ve been surprised that whilst there has been a lot of interest in venture debt and the value it can have to founders and investors alike, there is a still an air of conservatism and scepticism for many.

Why is this? I’ve considered why this is the case and spoken to several founders and investors over time to better understand.

1. It’s new

Venture debt as a product is relatively new to Australia. With any product there are always early adopters willing to initially try but generally new things are met with caution, until there is a positive feedback loop of others’ experiencing.

Whilst venture debt has plenty of benefits (see prior blog post by my colleague James), there are still some risks if the company materially underperforms.

Experiencing the product first-hand or being recommended it by other founders / investors who have had a positive experience, makes it a much easier decision.

I recommend that founders speak to others who have used the product and get references on the lenders, especially where things haven’t gone to plan. Who you take venture debt from is way more important than who you take a mortgage from. Make sure the venture debt provider has experience, understands the product, understands your business, and behaves well in good times and bad.

The team at OneVentures including our Israeli partner have a lot of experience lending to over 200 technology companies globally (Australia, US, Europe, Israel).

2. Tainted by the Wild West

Negativity bias is psychologically hardwired into us as humans. If we have a bad experience it weighs more heavily on us than a positive one.

Before established, experienced, trustworthy venture debt providers entered the Australian market, ad hoc debt deals were done by opportunistic players in the market. There was no market per se and therefore lenders were overcharging and / or offering off-market terms. Lenders applied traditional debt terms better suited to other situations, for example property but were not fit for purpose for a high growth technology company. In this way, it was like trying to force a square peg into a round hole.

This tainted the idea of using debt as companies either overpaid, were too restricted, or were constantly looking over their shoulder worried they would trip a covenant and have their equity value destroyed. Also, when things didn’t go to plan (as often there are unexpected events), the experience was stressful and counter-productive.

3. Misunderstanding

Venture debt in Australia (globally for that matter) is still grossly misunderstood. This can lead to founders / investors taking excessive risk by using the product when they shouldn’t or overleveraging their business by taking on more debt than it can support. A lack of understanding may also result in deciding not to use the product at all because of an inability to correctly evaluate the benefits / risks

Through education and a better understanding of the product and when it could be used, it can be properly assessed as a viable option, and structured and sized to fit the needs of the company.

Common misconceptions:

• It is a funding of last resort when equity cannot be found at any price, i.e. a back up option
• It provides short term bridge funding which is always repaid at the next equity round
• Taking venture debt will impact my ability to raise future equity rounds
• The venture debt provider wants something to go wrong so they can take ownership of the business
• I require significant hard assets or cash flow to access such funding

All of the above are incorrect. Venture debt can be used for a variety of uses, both at or around the time of an equity financing round or between them. It should be used to compliment equity finance and not act as a complete replacement. Used correctly it will help magnify the returns of all shareholders through providing access to capital to invest and increase company value without giving up so much of the shareholder’s “pie”.

A venture debt provider should be aligned with shareholders in the objective of building value, and therefore be viewed positively by existing and potential future investors. The venture debt provider should be patient riding the ups and downs, and want the best for the company. Actually, many providers (like ourselves) will take some of their return from future equity gain (through a warrant) aligning interests further.

Be sure to get to know the product better, way in advance of requiring it, and reach out to ask questions. A good provider should be transparent and candid regarding company fit and the correct structure.

Back to my opening question….

I feel the Aussie conservatism to the product may be somewhat justified today but is quickly changing, and with time will diminish. The venture capital market in Australia is rapidly maturing and becoming more sophisticated and with it comes new financial products.

Globally the product is on the rise with rapid increases in its popularity. In the US alone, venture debt has grown 5x over the period from 2010 to 2019 reaching US $25bn last year. I expect Australia to experience similar growth.