The Business Model of VCs vs. Venture Debt Funds by Joyce Mackenzie Liu

TL;DR - Venture Debt generates less than venture capital and has a completely different business model.

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Topic Tags - Incentives, Venture debt, venture capital, statistics, business model

Questions answered:

  • What is the difference between venture debt and venture capital?
  • How do Venture Debt firms make money?
  • How much are VC expected to return?
  • How much are Venture debt firms expected to return?

Summary:

  • VC funds are expected to return 3x the capital raised in 10 years. That is 12% a year.
    • Because only 20% of the investments will return the fund, each investment should have the potential to return 60% annually.
  • Venture Debt funds are expected to return 1.5x the capital raised in 10 years.
  • Main differences between the two are:
    • The failure rate of Venture debt is a lot lower, this is partly because venture debt firms fund venture capital-funded startups, which have already been screened.
    • Venture Debt is a yield instrument, “income is generated through a steady and frequent stream of future cash expected.” VC firms invest and hold their equity until exit.
      • Venture Debt profits from “(i) coupon or interest paid monthly, (ii) closing/transaction and maturity/end of loan fees, (iii) repayment schedule, and (iv) warrants.” Warrants allow the Venture Debt firm to buy equity.
  • For Venture Debt lenders, initial capital is repaid in 15-18 months in a 3-year loan, the rest is profit.
  • Venture Debt funds can also reinvest capital commit at least once. VCs are not allowed to do this.
  • Successful venture debt can generate 10-13% on debt alone and 20+% on warrants.
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