Bridging Equity and Debt: Rachel Lau’s Insights on Venture Debt Financing

Venture debt financing is an alternative form of funding often used by high-growth startups to extend their runway without diluting equity. Unlike traditional loans, venture debt is typically offered to companies that have already secured venture capital funding and can provide startups with the capital they need to scale operations, develop new products, or enter new markets. It serves as a complement to equity financing and allows founders to maintain more ownership while still gaining access to vital resources for growth. This form of financing is particularly appealing to startups looking to optimize their capital structure and manage risk while pursuing aggressive expansion goals.

Rachel Lau has been a key figure in the venture debt space, playing a crucial role in bridging the gap between traditional financing and the needs of emerging startups. Rachel Lau is a prominent figure in venture capital, celebrated for her strategic leadership at RHL Ventures and Iris Capital Partners. Additionally, she has been known to leverage her extensive experience in multi-asset class investments across three continents.

In recognition of her outstanding contributions to the industry, Rachel has been named AsiaTechDaily’s Investor of the Month. We recently had the opportunity to interview her, where she shared her insights on investment strategies, the evolving demand for venture debt, and advice for entrepreneurs navigating today’s market.

You’re known for bridging the gap between private and public equity markets by applying best practices from both. Can you explain how this philosophy is implemented in your investment strategy?

The biggest difference between private and public funds is the availability of information and, therefore, the reliability of that information. In the private space, there’s also more reliance on a founder’s long-term vision, whereas public equities are about trading on the company’s quarterly milestones. Given that we are longer-term patient capital, we are able to analyze companies and also focus on their execution of long-term strategy. 

How do you decide when to offer venture debt versus other types of financing, and what factors are most critical in that decision?

When deciding whether to offer venture debt or other types of financing, several key factors should be considered:

1.  Company Stage and Risk Profile:

-Early-Stage Startups: Venture debt can be a suitable option for early-stage startups with promising growth potential but may not require significant equity dilution. It can provide bridge financing between Series A and Series B rounds.

-Later-Stage Companies: For later-stage companies with a proven track record and a clear path to profitability, venture debt can be used to fuel expansion, fund working capital, or refinance existing debt.

2. Critical Factors:

-Cash Flow: We prioritize companies that are revenue-generating, close to break-even, or already profitable.

-Cash Burn: We prefer companies with a declining cash burn year over year.

-Runway: We aim for companies with a runway of 6-12 months.

-Cap Table: We consider the quality of previous equity investors as an indicator of the company’s potential.

-Revenue Growth: Given our interest in warrants, we evaluate the company’s growth potential and favor high-growth companies.

3. Debt Structure and Terms:

-Interest Rates: Venture debt often involves higher interest rates compared to traditional loans, reflecting the higher risk associated with investing in early-stage companies.

-Repayment Terms: The repayment schedule should align with the company’s expected cash flow and growth trajectory. 

-Warrants: Our deal structure typically includes warrants amounting to 10-20% of the loan amount per year

-Covenants: The terms and conditions of the debt, including covenants and restrictions, should be carefully negotiated to protect the lender’s interests while supporting the company’s growth.

4. Alternative Financing Options:

–Equity Financing: Equity financing, such as venture capital or private equity, involves the sale of ownership in the company. It can provide significant capital but often comes with greater dilution and control implications.

-Traditional Debt: Traditional debt financing, such as bank loans or bonds, typically involves lower interest rates but may require stronger collateral or financial guarantees.

As a co-founder and managing partner of Iris Capital Partners, what led you to focus on providing private credit solutions, particularly in the form of venture debt financing?

Private credit and venture debt have been a staple in Western markets for quite some time, with SVB being a prime example. However, the recent surge in interest rates has created a favorable environment for these alternative financing options. Investors in companies’ existing cap tables have been urging founders to consider credit as a less dilutive alternative to equity.

From a cost of capital perspective, credit can be significantly cheaper than equity, especially for companies with ambitious growth plans. For instance, if a company expects to achieve 5x revenue growth, the cost of equity through a traditional fundraising round could be as high as 500%. In contrast, credit financing often offers a much more affordable option.”

What trends are you noticing in the demand for venture debt financing among Southeast Asian startups, and how is Iris Capital positioned to meet this demand?

At Iris, we’ve conducted a survey of 100 founders in the region to understand how credit is becoming mainstream for SEA startups in the region.

2 Main Trends:

–Cyclical growth: Equity slowdown from 2023 onwards led to higher adoption of alternative financing

-Demand Supply Growth: Increased awareness and access to non-dilutive sources of funding

In our survey, 68% of founders have displayed interest in credit as part of their next fundraising and 61% of players are willing to substitute >20% of their next fundraising with Venture Debt

Startups frustrations

38% of them are unable to obtain loans from the banks because banks display limited understanding of tech companies. These founders have no hard assets that the banks can secure the loan against and finally many do not fulfill the criteria of having at least 2 years of operations despite having stellar growth.

Other pain points include:

-The bank process is long, tedious, lots of paperwork and takes 5-6 months

-A small number of companies don’t even try to apply, given unlikely success

-Companies want more than just money and are looking for strategic advice

Meeting this demand

We’re coming towards the end of our investment period but are looking to fundraise for Iris Fund II!

How has your broad experience in finance influenced your approach to evaluating risk and spotting opportunities in venture capital and private credit?

I’ve realised that all investments whether VC, PE, Private credit or public equities is similar as it just factors in risks and cost of capital. If you are able to manage cashflow well, ultimately, it is the fundamentals of the business that is most important!

Could you share some insights from your time with the Hong Kong chapter of Ellevate and EMpower that have influenced your approach to supporting entrepreneurs?

At Empower, we aim to create meaningful social impact. It has taught me to facilitate programs that support underserved communities, promote gender equality, and foster economic development. My commitment to inclusivity ensures that Empower’s efforts are accessible to diverse populations, addressing systemic inequalities and contributing to a more equitable society. Her work exemplifies how targeted, compassionate leadership can drive positive change on a global scale.

What advice would you give entrepreneurs seeking to secure venture capital or venture debt in today’s market?

The key thing would be to demonstrate traction and momentum.

-Customer Acquisition: Show that you have a growing customer base and positive customer feedback.

-Revenue Growth: Demonstrate consistent revenue growth and a sustainable business model. 

Having a plan for the use of funds, successfully raising money, and not deploying it is equally as bad as deploying the money badly, so make sure to develop a robust plan.

Be Patient and Persistent:

–Multiple Meetings: Be prepared for multiple rounds of meetings and negotiations with potential investors.

–Maintain Momentum: Keep your company’s momentum going by focusing on growth and achieving key milestones.

How is the current economic climate impacting the strategies and priorities of venture capital and private credit firms like RHL Ventures and Iris Capital Partners?

There is an increased focus on profitability. We are prioritizing investments in companies with stronger revenue generation capabilities and more sustainable business models.

Focus on Sustainable Investments. There’s a growing trend towards investing in companies with sustainable business practices and positive social or environmental impact.

Lastly, are there any specific sectors or industries that you believe have untapped potential for investment and growth?

The private asset class space is hugely untapped, and ASEAN is underinvested in it. Among the markets are tech and consumer, both relatively untapped and would benefit from more sophistication. 

As Rachel Lau continues to shape the landscape of venture debt financing in Southeast Asia, her insights remain invaluable. 

We invite you to attend our upcoming Innovation Exchange Program. During this program, you will hear from Rachel directly and engage in an interactive discussion on the role of venture debt in startup financing. Don’t miss this chance to gain expert guidance and connect with fellow entrepreneurs. 

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