Venture Debt: Why it’s attractive for founders, investors and the UK economy

Co-authored by Mei Lim, CFO, and Sonia Powar, Venture Partner at Anthemis, who put forward the argument that despite the sectors rapid growth in the US, the UK venture debt market is still currently restrained by a series of barriers to investment.

Venture Debt, also known as Growth Credit, is on the up but could and should be growing even faster to fund innovation, growth and returns for the UK economy.

What is venture debt is a common question, which sets the first challenge to growth. Making sure that both founders and investors understand the unique dynamics of this growth tool, when and what it can be used for and the risk adjusted returns it delivers is a key step.

Venture debt is typically a 3-4 year term loan with monthly interest and amortisation payments alongside an equity warrant making the lender more aligned with the shareholders than a traditional bank. It is used by high growth companies who aren't necessarily profitable yet to fund specific growth projects delivering the next milestone or as the final funding round to get them to profitability. It enables founders to raise non-dilutive capital and is a complementary tool to a thriving venture capital ecosystem. With many companies focusing on achieving profitability earlier in their lifecycle (rather than “growth at all costs”), venture debt has also become accessible earlier. Alongside this, capital efficiency is paramount, to ensure that value is being created in proportion to how it is being funded.

Unlike venture capital, which targets companies capable of outlier returns, venture debt has a different return profile broadening access to capital for a wider pool of companies – many responsible for driving regional growth, productivity, and employment.

These trends have seen new sources of capital enter the ecosystem - Blackrock’s acquisition of Kreos and HSBC’s acquisition of the UK arm of SVB, marking the growing importance and untapped potential of venture debt.

Investors should be attracted to the private credit characteristics of high yield and regular capital repayments in cash generating a faster and more predictable return as well as venture type upside through the warrants.

However, despite the macroeconomic case, two barriers continue to constrain the growth of venture debt - UK institutional investors often find it difficult to fund venture debt funds:

• Venture debt doesn’t fall neatly within existing asset allocations (is it venture or is it private credit?);
• Individual venture debt fund providers, while high-performing and aligned with policy goals, their fund sizes are frequently perceived as too small in isolation for standard LP cheques.

To date British Business Investments has been a significant player in the establishment of venture debt in the UK. However, apart from the BBI, the UK private sector still accounts for woefully less than 5% of total capital raised – despite >25% of capital raised being lent to UK businesses.

This capital mismatch means too many UK scale-ups are sold early, and UK institutional investors are missing out on attractive returns with future gains going offshore.

Government initiatives and policy change is required to support the expansion of venture debt for the benefit of all UK stakeholders. The Mansion House Reforms have created a vital and timely opportunity to diversify and strengthen the UK’s growth finance ecosystem. We would recommend venture debt be more explicitly incorporated into Mansion House 2.0, particularly as part of the work being done by the Treasury and The Lord Mayor on institutional capital flows and SME financing. We need to see options and pathways that enable and ensure all UK investors can contribute and benefit meaningfully from all high-growth opportunities in the UK economy. 

This priority, both via recognising it as a distinct asset class and being part of the proposed Mansion House fund of funds solution, supports a broader level of innovation, growth, employment, risk balanced returns and capital efficiency. This in turn enables an expanded route to achieving the UK’s goals for our environment and climate as well as supporting greater diversity, equity and inclusion across all regions.

The US has led the way for venture debt, helping to scale some of the most successful technology companies. With modest, well-targeted policy support, the UK can equally become a global leader in this asset class - giving the most promising growth companies the financial runway to remain, grow and lead from the UK.

Authored by Mei Lim, CFO and Sonia Powar, Venture Partner at Anthemis

The opinions expressed in this article are those of the authors. For more insights from Anthemis, visit Insights - Anthemis.