The Rise of European Venture Debt

11 December 2024

For a long time, debt finance was a foreign language for many founders. Raising capital meant an equity funding round. Even ten or twelve years ago, there was a lack of understanding about how debt worked and uncertainty around whether it was appropriate for startups. Europe lagged significantly behind the US, where this has been an established asset class for decades.

Now venture debt is both a recognised and rapidly growing feature of the European market, especially in the UK. In the first half of 2024, deal volume topped  €17.2bn, on track to exceed 2022’s record level of €24.2bn. In 2014, that figure was just €1.28bn.

The underlying shift has been the increasing recognition of what venture debt is, how it works and how it can benefit companies experiencing the unpredictable growth journey of a venture-backed startup. 

Supply meets demand

The rise of venture debt in Europe has only been possible because it works for lenders as much as borrowers. A venture debt fund is not dependent on exits and achieves a fixed return based on interest and fees. For LPs, there is the attraction of a return that is contractual rather than being overly reliant on the growth and performance of the company, as well as the reassurance of being senior to equity holders in the cap table. In addition, debt funds are generally set up to return capital back to their investors more quickly than equity counterparts.

Until quite recently, dedicated venture debt funds were rare in Europe. But they have grown in number as demand for the asset class has risen from founders and LPs have seen how debt investments can diversify their portfolios. While short-term market conditions have played a role in the rise of venture debt, the underlying trend was and remains upwards regardless of the wider funding landscape.

Debt is a distinctive source of funding which founders have come to understand as a complementary force to equity investment. Its place in the venture market is increasingly assured regardless of the equity funding environment, and as the sector grows, we can also expect it to specialise, with funds that focus on a particular sector or region.

“British Business Investments has been backing venture debt across Europe, with a focus on the UK, for the last eight years. We see a strong reason for investing, backing fast-growing innovative businesses and helping them to achieve growth without reducing control of their company,” said Geoff Whiteland, Senior Investment Director, British Business Investments.

“Venture debt is complementary to venture capital, allowing entrepreneurs to prolong their operational timeline, minimise capital costs, and foster continuous innovation. By continuing to back venture debt providers like Salica, we help innovative companies to unlock rapid growth and support the development of future market leaders.”

When debt and equity dance

More startup founders now understand the particular role that venture debt can play. The right mix of debt and equity can be a powerful combination: equity is often the cornerstone of a cap table, but debt can offer flexibility and firepower, often at the time when companies most need it.

For example, a company may need to boost working capital to pursue a particular growth opportunity, or to extend its runway between equity funding rounds. In these circumstances, debt finance is often quicker to secure than equity funding and its terms can be more flexible. And in times when there is more onus on companies to be more self-sufficient and prioritise profitability over growth-at-all-costs, venture debt can help to answer that need.  When early adopters demonstrated it could add value, awareness of the asset class increased, referrals picked up and momentum grew.

Debt’s distinctive role

Including previous roles, the team behind the Salica Venture Debt Fund has now completed close to a hundred venture debt transactions. In that time, the team has seen the distinctive role that debt finance can play for high-growth startups. In one case, a patent-rich company with a high level of management ownership took on venture debt because the founder was unwilling to accept further dilution. That funding enabled the business to build out its sales team and considerably enhance market traction. When it was acquired, owners – including existing equity investors – enjoyed a materially superior return because of the decision to seek debt funding instead of equity at a critical juncture.

That is one example of the kind of startup for which venture debt is suited: a company that has strong IP assets and needs to buy time to deepen product-market fit. Another, the most prevalent category in venture debt, are SaaS companies whose recurring revenue gives a degree of clarity about medium-term financial strength.

Companies like these fit the mould for venture debt providers, which cannot rely as traditional lenders do on tangible assets and positive cashflows when underwriting loans. Instead, they look more broadly at the financial strength of a business – revenue, customer profile and cash runway; its ability to be flexible and change course to reach breakeven in a downside scenario; the nature of the IP and products; and the quality of equity provision which has already gone into the company.

Equally, venture debt is not for every company, including those past the ARR threshold (around £2m) required to access this kind of finance. Not every founder or management team needs to be accountable to a repayment schedule, or to put in place the additional financial reporting requirements, which can occasionally exceed those required by equity investors. Venture debt can be a signal of financial maturity for companies nearing profitability or eyeing an exit, but for other startups it may be too soon.

Adding depth and variety

Over the last decade, venture debt has gone from a relative unknown for European startups to an established part of the growth playbook for many. It is a different kind of investment from a different kind of investor – one that is relevant for companies that must navigate a volatile funding environment and a new reality in which startups stay in private markets for longer and need to build a different kind of runway.

Venture debt adds to the depth and variety of the funding landscape without displacing what was already there. As an asset class it is here to stay, giving fast-growth startups another tool in the kit box to tackle the always challenging and increasingly complex task of trying to grow, compete and create lasting value.