Why are Aussies conservative towards venture debt? OneVentures principal Nick Gainsley has three theories

I’ve been in Australia for just over 18 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 Britain’s long-distance cousin would view financial products in a similar way. In fact, I thought Australians being more laid back, open and willing to try new things would actually lead to strong demand.

Consumer debt is a well-trodden path, after all, as is leverage in private equity.

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

Why is this?

After considering why this is the case, and speaking to several founders and investors over time to better understand, I have come to three conclusions.

1. It’s new

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

While venture debt has plenty of benefits, there are still some risks if the company materially underperforms.

Experiencing venture debt firsthand, or being recommended it by other founders or investors who’ve had a positive experience, makes it a much easier decision. 

I recommend that founders speak to others who have used venture debt 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.

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 or offering off-market terms.

Lenders applied traditional debt terms better suited to other situations — for example, property — that 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 (and globally, for that matter) is still grossly misunderstood.

This can lead to founders and investors taking excessive risks by using venture debt 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 venture debt at all because of an inability to correctly evaluate the benefits and risks.

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

Common misconceptions about venture debt:

1. It is a last-resort, backup funding option for when equity cannot be found at any price;
2. It provides short-term bridge funding which is always repaid at the next equity round;
3. It will impact an ability to raise future equity rounds; 
4. The provider wants something to go wrong so they can take ownership of the business; and
5. Founders need significant hard assets or cashflow to access such funding.

All of the above is incorrect.

Venture debt can be used for a variety of uses, both at or near the time of an equity financing round or between them.

It should be used to complement 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 will take some of their return from future equity gain (through a warrant) which aligns 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 venture debt 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, venture debt is on the rise, with rapid increases in its popularity.

In the US alone, venture debt has grown five times over the period from 2010 to 2019, reaching US$25 billion last year.

I expect Australia to experience similar growth.