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Loans for Start-ups as a New Asset Class in Europe

The full article in German can be found below.

In the insightful article by Sven Janssen, CEO of Tradition Meets Future, featured in the “Börsen-Zeitung” on July 30, 2021, the author discusses the changing trends in startup financing in Europe. Janssen examines the practice of providing loans to emerging companies, contrasting it with the traditional model of equity financing that is common across the continent. He explains how venture capital investors, through venture equity funds, assume the financial risks of supporting new enterprises, with the expectation that a small portion of these investments will generate enough returns to cover the losses from others.

Venture or Growth debt, as Janssen introduces, emerges as an innovative alternative amidst this backdrop. It targets growth companies that might not qualify for traditional financing due to a lack of a credit history or negative cash flow. Janssen emphasizes that venture debt allows these companies to secure funding without the immediate need to give up equity, thus preserving their valuation and ownership structure.

To illustrate the potential of venture debt, Janssen recounts the story of a now-famous Berlin startup, initially without customers but holding a promising patent. This early-stage company managed to secure a loan that came with a 20% profit-sharing agreement. This financial support catalyzed its transformation into what is now known as Siemens AG, a global conglomerate with substantial revenues and workforce. This story underlines the potential of venture debt to act as a critical enabler for companies with significant growth prospects.

Janssen further explores the mechanics of venture debt, detailing how investors need to adopt dual roles: one as an equity investor and the other as a lender. From the equity perspective, the assessment focuses on the viability of the business model, the trajectory of revenue growth, and the capabilities of the management team. From the lending perspective, the evaluation shifts towards the company’s ability to service the debt, including interest payments and the principal amount, and the adequacy of collateral should financial difficulties arise.

The author points out that while venture debt entails a closer examination of a company’s financial health and growth prospects, it also presents a unique risk-return profile. Venture debt funds aim for average annual returns of 10 to 15% based solely on interest payments, with potential total returns including equity components reaching 15 to 25%. These figures present venture debt as an attractive option for investors, offering a more favorable risk-return balance compared to traditional venture capital, which targets higher returns but also entails a longer capital commitment and a higher risk profile.

Janssen’s analysis extends to the strategic implications for startups opting for venture debt. He argues that venture debt can be the right move for companies poised for rapid growth, as it allows them to leverage additional capital without further diluting their equity. This strategic financing choice can enable startups to reach more favorable valuations at later funding rounds, reflecting their growth and success.

In concluding, Janssen highlights the nascent state of venture debt in Europe compared to the United States, where it accounts for a significant portion of venture capital transactions. He attributes the lower adoption in Europe to a smaller pool of suitable technology-driven companies, but notes the changing landscape as the European startup ecosystem matures. With increasing numbers of viable candidates for venture debt, the potential market in Europe could expand significantly, presenting new opportunities for investors and offering startups a valuable tool for growth and development.

In his detailed analysis, Janssen not only highlights the significant role of venture debt in transforming the startup financing landscape in Europe but also prompts a reconsideration of conventional financing models due to changing market dynamics and emerging opportunities.

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