Why successful entrepreneurs choose venture debt?

July 9, 2020 2:57 pm

As venture debt continues to emerge as an alternative asset class allowing technology company founders to raise capital, we continue sharing our experience and expertise with founders about the benefits and use cases of venture debt.

In case you haven’t previously heard of venture debt or do not fully understand the concept — venture debt is an alternative financing option for businesses in the form of a term loan (which works very similarly to a typical mortgage) that inherently comes with a clear benefit — reduced dilution.

In this article, we wanted to talk a little more about the benefits of venture debt and what better way than to ask a founder who had previously used venture debt to share his story.

With that in mind, we were lucky to connect with Jared Schrieber, ex-CEO and Co-Founder of InfoScout, who shared his story with us about launching and growing InfoScout and his experience with raising venture debt at the right time during the growth trajectory of his Company.

Donatella: Jared, to start with — can you tell us a little bit more about your journey with InfoScout?

Jared: It started back in 2011 when me and my former colleague Jon Brelig came up with an idea for a company that would track consumer purchase behaviors across retailers via smartphone apps that incentivized people to take pictures of their shopping receipts. This novel approach seemed far superior to how billion-dollar incumbents like Nielsen and Kantar had consumers scanning the barcodes of each and every item brought home. With my experience growing Retail Solutions and Jon’s track record of building and successfully exiting several tech startups, we believed that attracting financing for our idea would be a ‘walk in the park’. But the reality turned out to be thornier than expected. With dozens of frustrating rides up and down Sand Hill road, requests to show ‘traction’, a flurry of rejection emails, we were at the brink of a breakdown.

InfoScout is a marketing intelligence firm that brings together omnichannel consumer purchases with surveys and advertising exposures to helpbrands, retailers and marketing agencies better understand why consumers buy. Vista Equity Partners acquired InfoScout in 2017 and merged it with Market Track to form Numerator.

However, as with many good things that come after hardship, with the support of our families, friends and advisors we managed to secure angel funding which allowed us to bring our idea to market and begin signing our first customers.

Within a few months we were already capturing data from as many shopping trips per day as our legacy competitors and were well positioned to land a Series A round from a top tier VC — Bain Capital Ventures. This capital allowed us to truly ramp up our data collection efforts and accelerate sales growth. Having solved the chicken (B2B clients) and the egg (B2C consumers) problem and landing very prominent customers, we scored a large Series B strategic investment from WPP/ Kantar. That investment truly allowed us to build the highly coveted flywheel of growth that propelled us towards our goal of displacing the large incumbent players in our industry.

Donatella: Turning towards the topic of venture debt — you touched upon the equity rounds that the company managed to attract, however, when was that point in time when you decided to use venture debt?

Jared: As a result of our Series B financing we managed to achieve stellar growth that, bought us quite a bit of runway. Nevertheless, when InfoScout started approaching the time when we had to start thinking about raising additional cash to take the Company to the next stage, we carefully considered our options. Although we had around nine months of cash on hand, we felt it was important to secure some additional funding to be able to keep our foot on the gas and continue aggressively growing our revenue bookings. We explored a traditional Series C growth equity round, as well as taking on further equity investments from strategic partners, but these options came with significant dilution to us as founders, to our employees and to our shareholders.

We were already broadly familiar with various debt products, including venture debt since we have previously used other forms of debt in the Company. At that specific time we were in need of a flexible financing solution that provided more capital than a traditional term debt or a line of credit and venture debt ended up being the best fit. We partnered with a US based venture debt fund who offered us a standard venture debt facility that helped us extend our runway.

Donatella: Since we’re talking about the benefits of venture debt, can you elaborate on what exactly swayed your decision to go with venture debt as opposed to equity financing?

Jared: Well, there were a number of factors, but as I have already mentioned, the first and the obvious one that comes to mind was the reduced dilution. Naturally debt is a non-dilutive instrument, so it allowed us to raise additional capital without giving up a significant share of the business. And although there are warrants involved, they represented a small equity component by comparison.

Donatella: Agreed, dilution is probably the number one benefit anyone would call out when speaking of venture debt. What we often hear as the counter argument is that reduced dilution comes at a cost — you have to pay interest on debt, while equity comes as free money. What was your thinking about it?

Jared: While it is true that with any debt you incur the cost of interest, it is actually a common misconception that debt is more expensive than equity. When deciding between venture debt and equity we looked at the broader picture, which included the cost of dilution — i.e. how much value we would have been giving away when raising debt versus equity. Turned out to be that the total cost of the debt facility (including all the interest, fees and warrants) to the existing shareholders under almost every future scenario, venture debt would cost existing shareholders a fraction of what equity dilution would have cost. And that really swayed our board’s decision to go with venture debt.

Donatella: Indeed, one should look at it not only from a short term cash-flow standpoint, but from a value perspective. Giving away a stake in a growing company is much more expensive than the interest on the loan. But, dilution aside, what were the other benefits that you saw in venture debt?

Jared: Flexibility of the funding and the light touch approach of the venture debt fund was a clear advantage. Unlike with equity rounds, we did not have to engage in the painful valuation discussion. We were also almost two years down the line from raising our Series B round and attracting fresh equity into the company implied large cheques, that were not necessarily warranted at that point in time. Venture debt was very flexible from the funding amount perspective and structured the facility that best suited our funding needs. And, unlike with equity, we could repay the debt any time, in case we didn’t need all of the capital.

Donatella: That’s true but that is also the case for other types of debt funding and things like revolving debt facilities are claimed to be even more flexible. Given that you already had experience with other types of debt funding, why did you finally decide to go with venture debt?

Jared: Yes, indeed there are also term loans and revolving credit facilities provided by banks, but, first of all, banks in the US are very conservative with lending to startups and hence the flexibility and sizes of their loans are limited. In Europe the situation is even more difficult where only a small subset of EBITDA profitable companies can receive bank loans. And even though some of the more traditional banks are entering the startup scene and begin financing cash burning companies, they maintain their “traditional” banking outlooks on credit risks. If you’re working with a bank — you’re more than likely to see financial covenants in your debt offering. If you are a growing startup — these can significantly inhibit your ability to grow through burn or cash level covenants. Also, revolving credit facilities are indeed flexible instruments but most often the amount that can be drawn is expressed as a multiple of your revenues. When you consider the pessimistic development scenarios, which can come about as a result of external shocks that are outside of your control (such as the COVID-19 pandemic) — you may end up with a much smaller cash cushion than you originally planned for.

Donatella: Are there any further thoughts, insights or recommendations that you can share with the founders that will be reading this article?

Jared: It is quite common for the startup community to see debt as a source of financing of last resort — i.e. you will raise debt if you cannot raise any VC money. And that is also one of the wildest misconceptions, in my opinion. Many InfoScout executives and board members initially opposed the idea of venture debt. However, a model of potential future scenarios (including further funding and valuations) helped to convince the Board that venture debt was the right tool and eventually it did turn out to be the case. So my advice here would be to get as much understanding as possible and make sure that all the stakeholders are on the same page. One of the best ways to do it is to partner with a venture debt fund that is willing to invest time in your education and help you build and support a case for a venture debt investment,

And also, there is one other thing that came to me in hindsight. It happened so that we found an exit path and sold the company within a year of taking on the venture debt. Thinking about how things could have panned out, had we taken equity, I realized that exiting the company may have been much more challenging. With taking on new equity investors, you are essentially resetting the target valuation that the company is expected to achieve. New equity investors want to earn their multiples and it is very likely that the outstanding exit we took would not have been their ideal scenario and hence this ideal path could have been blocked. So timing is also very important.

Jared Schrieber is a technology entrepreneur, co-founder of InfoScout (now part of Numerator) — one of the world’s fastest growing market intelligence companies. Jared remains involved in Numerator through his involvement on the Board, but is also an active angel investor and co-founder of Revolution Robotics Foundation that is aimed to create an open-source platform designed to make robotics education and competitions accessible and enjoyable for kids globally.”

Flashpoint Venture Debt provides debt financing to later stage international tech business by founders from Emerging Europe, Finland and Israel. We continue to actively pursue our longstanding quest to “educate” Founders and investors in the European market on the attractiveness and best use cases of venture debt for high growth VC-backed technology companies.