New analysis from PitchBook reinforces what so many founders already know: Cash is tight.

With the notable exception of AI startups, founders in almost every sector are finding it harder and harder to secure venture capital (VC) funding.

The tightening of investment criteria, increased scrutiny, and a more cautious approach by investors have made the fundraising landscape more difficult than ever. The PitchBook data shows the time between fundraising rounds has been increasing steadily since Q3 2022 and many founders are facing tough choices about how best to deploy what capital they have to ensure their businesses remain viable and their dreams remain alive.  

There are a number of factors underlying the current challenge of securing venture capital:

• Economic Uncertainty: Global economic instability has led to a more cautious approach by venture capitalists. Investors are more risk-averse, focusing on startups with proven business models and clear paths to profitability, making things particularly difficult for early stage ventures.

• Stricter Investment Criteria: VCs are now scrutinizing potential investments more rigorously and startups need to demonstrate strong traction, significant market potential, and solid financial metrics to secure funding. The due diligence process has also become more extensive. Arguably this is not a bad thing, since greater scrutiny ultimately protects both investors and founders, but it does mean the fundraising process is longer and more arduous, which can be detrimental to startups that need immediate capital to fuel growth.

• Competitive Landscape: The number of startups seeking funding has increased, leading to heightened competition. PitchBook data suggests the U.S. has more startups than VCs can support: 55,000 venture-backed business all vying for investment, while some 2,000 VC firms have effectively hit pause on any new investments. With limited VC funds available, only the most promising startups can secure investment.

• Valuation Pressures: Startups often face pressure to accept lower valuations, which can dilute ownership more than initially anticipated. This is particularly challenging for founders looking to maintain control of their companies.

The Merits of Venture Debt in This Climate

While many founders still fight shy of taking on debt, and while venture debt is certainly not an alternative to VC investment, it should be a complementary part of any startup’s financial strategy and the smart use of venture debt can help cash-strapped founders navigate achieve the growth they seek even in the current challenging market conditions:

• Non-Dilutive Capital: One of the most significant advantages of venture debt is that it provides capital without diluting ownership. Founders can secure necessary funds while maintaining control of their company.

• Faster Access to Capital: Compared to the extended due diligence process of equity financing, venture debt can be arranged more quickly. This is crucial for startups that need immediate capital to seize growth opportunities.

• Extended Runway: Venture debt can extend a startup’s financial runway, providing the time needed to reach key milestones and improve metrics before the next equity round. This can result in better valuations and terms.

• Flexibility in Use of Funds: Venture debt can be used for various purposes, such as scaling operations, product development, and marketing efforts. This flexibility allows startups to allocate resources where they are most needed.

• Complementing Equity Financing: Venture debt is often used alongside equity financing to optimize a startup’s capital structure. It can bridge the gap between funding rounds, reducing the pressure to raise equity at unfavorable terms.

Real World Example: Supporting a Tech Startup

Consider a tech startup that has developed an innovative software platform. The founders have a solid business model and are seeking $60M of equity financing, based on their own valuation. However, pricing pressure on equity means they would be required to surrender more equity than they would like, in return for that $60M.

This is where venture debt comes into play. Instead of diluting their equity, the founders accept $40M in equity financing and take the remaining $20M in debt.

This strategic use of venture debt extends their financial runway, allowing them to achieve significant milestones and present a stronger case in the next equity round. When they eventually approach VCs again, they can do so with improved metrics and a higher valuation, ultimately securing better terms and preserving more ownership.

There are thousands of startups that find themselves in this kind of position and the smart use of venture debt, pursued with the buy-in of investors can be a lifeline that makes the difference between success and failure.