VC debt funding -- a key source of finance for US startups -- is finally coming to Australia

Web 3.0 hub: YBF Mesh. Image: Supplied

  • Debt capital funding, popular in Silicon Valley, is coming to Australia.
  • Adventure Capital is about to launch Omega Venture Debt.
  • The size of the fund is expected to hit $50 million with loans from $1 million to $7 million.

Australian startup founders, who sometimes despair at the equity deals offered by potential investors because it dilutes their stake in the businesses they created, will soon have better access to debt funding.

Debt venture capital (VC) funding is an integral part of the startup finance culture in the US where major players include Hercules Capital and Silicon Valley Bank but in Australia such funds are hard to get.

Adventure Capital, an Australian early-stage technology venture capital firm, is about to launch Omega Venture Debt. Mike Smith, the former CEO of the ANZ, is an Advisor and Investor.

“It very much complements venture capital on the equity side,” Stuart Richardson, Adventure Capital founder and managing partner, told Business Insider.

Richardson earlier this year wound down his executive role at startup hub YBF Ventures, which he founded in 2011 in Melbourne with Darcy Naunton inside an 1850s heritage-listed space formerly known as the York Butter Factory, to build new funds to back Australian technology startups.

The current equity venture capital trend in Australia is for larger raises going to later stage startups. Venture capital investment in Australia in the 2017-18 financial year hit a record $US630 million ($A849 million), according to the latest numbers compiled by KPMG.

Where equity venture capital works for the more immature business, those with a good idea but little in the way of customers or revenue, debt venture capital works better when a startup is gaining traction.

“With the increase in the amounts of venture capital and the maturity of the ecosystem we see this as a significant opportunity to accelerate the ecosystem and for more of Australia’s best and brightest to realize their potential growth levels,” says Richardson.

Omega Venture Debt is looking for startups with customers, those that have already revenue, and those in the B2B space, SaaS or SaaS businesses, marketplaces, and business areas such as Internet of Things.

The size of the loans would be be from $1 million to $7 million, with the Omega team already working on a pipeline of deals. The first fund of the series will land up to $50 million, funding 15 to 20 loans.

Other VC outfits are reported to be also looking at debt funds. Among them is OneVentures which expects to be writing loans to local “scale-ups” before the end of this year, according to Street Talk in the Australian Financial Review.

Up to now, the only other debt fund in Australia has been Partners for Growth offers, commercial lending for companies in need of growth capital.

John Anasis, the managing partner of Adventure Capital’s Omega debt fund, says he prefers the startups to have taken some form of venture capital by the time they look to debt to show that they’re actually prepared to on take external funding.

During his career as an investment banker, the last 10 years at Investec bank, he was seeing an increasing amount of companies seeking an alternative to equity financing, particularly those that were post revenue and well on track to break even.

“Banks were not setup to lend to these new economy businesses (nor should they some would say),” he says. “These companies had experienced significant dilution via VC investment and as a result were in my opinion greatly undercapitalised.”

Adventure Capital’s Stuart Richardson. Image: Supplied.

“I also spoke with a number of VCs and they were very vocal that venture debt was a staple complement to VC investment into companies in more developed geographies such as the US and that they would be supportive of such an offering arising for Aussie companies.

“Debt allows companies a safety net via an extended runway and it also provides or demonstrated discipline to repay debt, which organisations like the ASX would greatly welcome.”

Anasis says he’s looking for businesses that have either a strong track record in meeting milestones.

“The terms depend upon the underlying company, the borrower, but what we’re broadly going to be lending to is a two and three year duration,” he says.

“And the idea being that they’ll be able to service the debt and that that is not going to cause them issues or put the business into a level of distress.

“So it’s very important to note that this is not for a lender of last resorts style of the equation. It’s very much an extension and/or acceleration of the growth of the business that we’re looking towards.”

Part of the debt deal may include an option, by the debt fund, to take an equity stake sometime in the future.

Richardson says high-quality, bootstrapped companies haven’t been difficult to find.

“Given my history and also John’s history we’ve been building good relationships with founders and early investors who are very significant beneficiaries of this,” he says.

“So one of the beauties of the venture debt product is it actually brings a level of discipline into the business in order to be able to support the loan.

“But these loan covenants are a very positive thing for a business which is really just starting to scale and to grow and to want to be able to access more sophisticated sources of capital into the future.”

The due diligence needed for a debt-based investment is different to that of an equity-based deal.

“We’re very much needing to clearly understand how are they going to service this loan. And how are we going to work together to understand the risks that are involved,” he says.

Debt can be better than equity

John Henderson, a partner at AirTree Ventures, says there is a thriving venture debt ecosystem in the US and Europe.

“I think it’s great to see a second entrant to our market, and to give founders a choice of debt providers,” he told Business Insider.

“More venture debt is kind of a win-win-win for the ecosystem. It’s another financing option for founders which is less dilutive to them. If done well, founders can end up with more of their company after raising debt than equity.”

Sometimes using equity funding is inefficient. This is particularly so when the money is used to fund working capital or buy inventory.

“Debt is better than equity in that situation,” says Henderson.

“But as of today in Australia, it’s very difficult to get venture debt. Omega is filling a gap rather than competing with or replacing another form of finance.”

“Venture debt providers will typically charge slightly higher interest rates than banks and also look for some equity upside. Usually the way venture debt investments are structured is that the investor charges interest on the loan and also takes some warrants in the company, so if things really work out then they get a slice of the upside too.”

Henderson says the need for equity doesn’t go away.

“It’s not right for every company. There are a bunch of companies that will just raise equity,” he says.

“With that being said, certainly within our portfolio, I would say at least a third of companies should have venture debt. Only four of them do at the moment, and that’s mainly just because there is really only one provider servicing our market. It’s just a lack of options.”

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