High-growth companies are often focused on expansion and may require significant funding to support their growth plans. While equity financing from venture capital firms is a common source of funding, companies may also consider raising debt capital to finance their operations. However, even companies with impressive revenue and growth metrics may find it challenging to raise debt capital, especially from traditional bank lenders. This article will examine the challenges that high-growth companies may face when seeking debt financing, despite having an existing equity investment from a venture capital firm.
Debt Capacity Constraints:
One significant challenge that high-growth companies may encounter is debt capacity constraints imposed by lenders. Bank lenders often apply a net debt capacity of 3.0x EBITDA, meaning that net debt of the company cannot exceed three times the EBITDA that was last reported to the lender. This limit is intended to protect lenders from the risk of default in the event of an economic downturn or other adverse events. For companies with high growth rates, this may mean that their EBITDA is not yet sufficient to support the level of debt they require to finance their growth plans. In such cases, the company may need to explore alternative financing options, such as mezzanine financing or convertible debt, which typically carry higher interest rates or equity dilution respectively.
Lack of Profitability and Negative EBITDA:
Another challenge that high-growth companies may face when raising debt capital is their lack of profitability or negative EBITDA. Many traditional lenders, including banks, require borrowers to demonstrate a history of profitability or positive EBITDA to qualify for debt financing. However, for high-growth companies, profitability may not be a priority, as they may be focused on reinvesting their earnings to fuel further growth. As a result, they may not be able to meet the stringent requirements of traditional lenders. In such cases, companies may need to explore alternative lenders, such as credit funds, which may be willing to provide debt financing based on revenue growth rather than profitability.
Difficulty in Finding Affordable Debt:
Even if a high-growth company can't secure debt financing from bank lenders due to their lack of profitability or EBITDA, they may find it challenging to find affordable debt from alternative lenders. While credit funds and other alternative lenders may be more flexible in their lending criteria, they often charge higher interest rates than traditional lenders. This can be a significant challenge for high-growth companies that may not have sufficient cash flow to service the interest expense of their debt. In such cases, companies may need to consider dilutive financing options, such as equity financing or convertible debt, to finance their growth plans.
Conclusion:
High-growth companies with an existing equity investment from a venture capital firm may face several challenges when seeking debt financing, despite their impressive revenue and growth metrics. These include debt capacity constraints, lack of profitability, negative EBITDA, and difficulty in finding affordable debt from alternative lenders. By understanding these challenges, companies can prepare themselves for the debt financing process and explore alternative financing options if needed. It is essential to work closely with advisors and explore all available options to find the most appropriate funding structure to support their growth plans.
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About the author
Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of transactions across financing, M&A and derivatives with global corporates, private equity funds and financial sponsor groups.
About Langdon Capital
With a network of 700+ alternative investors, Langdon Capital raises debt and equity capital between £1m and £25m for high-growth and innovative companies in the technology, environmental impact and renewable energy sectors, who are preferably beyond a Series A funding round or equivalent, to help them fulfil their paths to profitability and growth ambitions.
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