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In my prior post, I described how the business models of venture capital (both equity and debt) operates. In this one, I will discuss why venture debt is a great source of capital to finance a continuously growing, predictable VC (or PE)-backed business.

Note: this is a series of posts in attempt to break apart the misconceptions about venture debt.

Fact #1: Debt is always cheaper than equity*

The cost of capital (i.e. expected return on capital for banks and venture lenders) is lower. Plain and simple.

For a venture equity fund, 3x is the minimum expected return on money spent. (Otherwise, an LP would invest in a PE fund which has perceived lower risk and higher ability to deploy more capital predictably throughout a business cycle.)

For a venture debt fund, the bar is 1.5x return on invested capital.

For more a detailed explanation, refer to this post.

*Two caveats:
(i) When debt and equity financing is structured ‘correctly’ (i.e. on-market terms from experienced lenders and investors), and
(ii) When the business continues to grow and/or there is little risk of running out of cash and going bankrupt.

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