How to Compare and Negotiate Venture Debt Term Sheets

Venture debt can be one of the most beneficial (and cost-effective) forms of long-term capital for startups when properly negotiated. The single most important factor in said negotiation is the quantity and quality of term sheets that a startup receives. Given you’re reading this guide, we’re going to assume you’re in this camp, having received more than one offer, and are looking for tips to compare and negotiate venture debt term sheets—if that’s the case, great you’ve come to the right place! In this guide, we break down the components of a term sheet, explore the key considerations for comparing offers, provide a framework for running a successful venture debt process, and share tips on negotiating this form of debt financing. Let’s dive in!

The key components of a venture debt term sheet

While venture debt term sheets can be structured drastically differently, they all share the same basic components; we’ve broken down each of them below.

Interest rate - the fee you pay over the life of the loan for borrowing the capital. There are two types: fixed rates, and floating rates.

• Fixed rates - as the name suggests, these stay the same throughout the life of the loan. They typically range from prime + 1-4%.
• Floating rates -  as the name suggests, these can change throughout the life of the loan. These typically start in the low prime +1-2% as an “introductory rate” and then ratchet up to prime +3-4% at about the midpoint to maturity.

Principal repayment structure - this outlines the payments you are required to make throughout the life of the loan, they can either be bullet or amortization. Typically it’s more beneficial for startups to pursue the bullet structure, so they can put the entire venture debt facility to work in the business.

• Amortized -  this structure involves regular payments of both principal and interest, throughout the life of the loan. Occasionally, the startup may receive an interest-only period of 12-18 months, because the loan amortizes and principal payments begin.
• Bullet - this structure defers principal repayment to the end of the loan term (maturity). Typically startups with a bullet must make interest-only payments throughout the life of the loan, but in some cases, those interest payments can be rolled into the bullet payment at maturity.  For more information, check out this guide on bullet loans.

Term length - this outlines the time until maturity. The most frequent terms we see are 36 and 48 months, which provide ample time for the startup to generate returns on the capital and repay the facility. Unless a startup needs venture debt for a bridge to get to their next equity round, typically the longer the term the better.

Covenants - these are rules and restrictions imposed by the lender to protect their interests and investment. There are three broad categories of covenants: affirmative, negative, and financial; check out this guide for the venture debt covenants, clauses, and provisions to avoid.

• Affirmative covenants - these require the startup to do specific things, such as consistently providing financial statements, maintaining insurance coverage, and complying with laws.
• Negative covenants - these prevent the borrower from doing specific things without permission, such as taking on additional debt, changing the leadership team, or making large capital outlays. 
• Financial covenants - these require the startup to maintain a certain level of financial performance and profitability.

Warrants and equity kickers
Warrants or “equity kickers” are options that allow the lender to purchase shares of your company's equity at a predetermined price before a predetermined date. They are often included in venture debt deals to sweeten the deal and historically ranged from 1-2%. That said, some lenders have moved to a zero-warrant structure.

Miscellaneous terms and fees
Venture debt agreements may contain various fees beyond interest rates, including origination fees, back-end fees, prepayment penalties, and legal fees. Check out this guide for a more in-depth look at the most common banking fees.

• Origination or facility fee - this is a fee assessed upfront for initiating the loan. It is typically 2% of the loan amount, payable in cash when the loan is funded.
• Back-end or maturity payment fee - this is a fee assessed upon the final payment of the loan. It is typically 1-3% payable in cash at the time of maturity. 
• Closing or legal fee - this is a fee that covers the legal fees (for the lender) associated with deal execution or provides a reduction in credit exposure for the lender.
• Prepayment penalty - this is a fee assessed for paying off the loan prior to its maturity date.

Key considerations for comparing venture debt lenders and term sheets

Comparing venture debt term sheets can be a challenging process especially if the basic terms and associated covenants are structured completely differently. Unfortunately, this happens quite frequently as lenders have different risk tolerances and perceptions of the deal, e.g. one lender may completely reject a loan application, whereas another may see the same details and offer preferred rates & terms to the startup. We’re by no means legal professionals, and this guide is by no means legal or financial advice, but below we’ve outlined some of the considerations we’d have when comparing lenders and term sheets.

Use case of the capital -  What you’re going to use the capital for is one of the most important things to consider when evaluating competing term sheets.

• E.g. if you need the capital to hold you over until your next raise, which you expect to close in the next quarter, then you don’t need to optimize for pricing or for term length. Instead, you’ll want to optimize for flexibility: no prepayment penalty, no all-asset lien, no negative pledge on IP, no warrants. 
• E.g. if you need the capital to hire engineers, or product managers for R&D purposes, then you’ll want to optimize for term length, and ensure that you receive an interest-only period of at least 12 months
• E.g. if you need the capital to invest in revenue-generating activities, and plan to repay the capital quickly, then you’ll likely want to have a bullet structure for the first six months, followed by amortization over the next 18 months. You’d also want to minimize the warrant coverage and the number of applicable financial covenants, which could be triggered during your growth phase.

Speed of funding & capacity to scale - Let’s be honest with each other, some lenders move quicker than others. How quickly you plan to deploy the capital, and your growth plans, although not captured in the term sheet should be considered. Some lenders have fixed terms and will not scale their capital facilities as you grow, while others are incredibly willing and able to do so. Some lenders' due diligence process may take months, while others may take just a few days, so this too should play into your decision.

Financial stability & relative confidence - Most venture debt facilities come with a slew of covenants: requirements for things you need to do, avoid, and maintain compliance with. These covenants can directly impact the day-to-day operations of a startup, and when triggered can cause a subsequent default (e.g. the worst-case scenario). Startups with highly dynamic financials or a low level of confidence around their ability to repay the debt are not a great fit for venture debt. Startups with relatively stable financials, on the other hand, maybe great candidates for venture debt.

Non-monetary benefits of working with the provider - Evaluate venture debt providers, in much the same way as you did your value-added equity investors', you know the angels on your cap table with connections with industry operators or suppliers, a box at the local sports arena, ties to the local government…etc. Some lenders will provide introductions to investors, partners, and potential customers, and additional support and resources as needed, while others will simply cut a check, so pick wisely.

Lender reputation  - As we’ve said in other guides, taking on venture debt is a lot like taking on venture capital–the lenders are tied to your business for its entirety, so you want to choose the right partner the first time. Backchannel with other founders who have worked with the lender in the past, ask about their experience: the good, the bad, and the ugly. Ask how communicative the lender was, how flexible they were, how understanding they were, and so on. You want to look out for red flags and understand how they might act if push comes to shove and things don’t turn out the way you expected.

Negotiating Venture Debt Term Sheets

Negotiating venture debt terms sheets is a lot like negotiating venture capital terms—hopefully, you come into the process with terms from at least two providers, you come prepared with a solid understanding of your needs and the current financial state of your startup, and you come into the conversation with a BATNA in case things don’t turn out as planned. Below we’ve outlined the basic steps for the negotiation process, for a more in-depth look at running an end-end venture debt process, check out the startup founders’ guide to raising venture debt in 2023.

Step 1: Setting clear objectives and priorities
Before you enter the negotiation process, you’ll want to have a clear understanding of preciously how much capital you are looking for, what you plan to use the capital for, the ideal timeline in which you’d like to pay it back, and the structure of that payback process. These should be based on your growth & headcount plans over the next 12-24 months and your level of confidence in said projections. You’ll also want to have a thorough understanding of your business: how much revenue you’re generating, your revenue growth rate, your revenue mix, your burn rate, your runway, your outstanding debt mix…etc. to make sure that you qualify for the funding. 

Step 2: Establish your non-negotiables 
Come up with a list of terms that you would not be comfortable agreeing to. These can be limits on the highest interest rate or warrant coverage you’d accept, limits on the shortest payback period you’d accept, or limits on the covenants you’d be prepared to accept: e.g. no all-asset liens or negative pledges on IP. Once you’ve come up with the list, then bucket them into three categories: 1) non-starters, the things that you would not accept no matter what the other terms were; 2) semi-negotiables, the items that you would not be happy with accepting, but could stomach them; 3) nice-to-haves, these are the terms that you would like to see, but are willing to give them up for something better.

Step 3: Heatmap the key terms 
Once you’ve received the term sheets, it’s time to pull out your spreadsheet and go line by line. First note the basics: headline interest rate, amount, term loan availability, interest-only period length, structure (amortizing vs bullet), milestone events…etc. Then get into the nitty gritty and note how the lender defines a default event: what triggers a default, and what happens following a default (restructuring, maturity date extension, premature repayment…etc.). Then break down the required covenants, the associated clauses that trigger during a default (e.g. change of ownership, material adverse change, investor abandonment…etc.), and the associated provisions (e.g. cross-default and cross-acceleration provisions). Check out this guide for a more detailed explanation of the most common venture debt covenants, clauses, and provisions.

Step 4: Reference the results of steps 1 & 2 and enter the negotiation
It's time to put your negotiation skills to the test, remember the more information you have the better. Start with the basics, amount, interest rate, and structure, and then work your way down to the more complex items. At some point (ideally the beginning) of the process you’ll want to bring your legal counsel into the mix. Remember: the goal of the negotiation process shouldn’t be to get everything you’re looking for, just the items that are most important to you, e.g. the non-starters and semi-negotiables. In our opinion, it's better to select the lender with the better reputation and the cleaner term sheet that has fewer covenants (e.g. no all-asset lien, no negative pledge on IP, no streamline trigger, no veto right…etc.)  than the lender that offers a slightly lower headline cost of capital (interest rate, warrant coverage..etc.) and a worse reputation.

Step 5: Ink the deal
You’re at the one-yard line, don’t fumble the ball with a last-minute request. If you’re happy (and comfortable) with the terms of the deal, then it's time to sign on the dotted line. Minor hesitations (and buyer's remorse) are normal, major concerns or reservations are not.

Final thoughts on comparing and negotiating venture debt term sheets

As outlined above, the process of comparing and negotiating venture debt term sheets (and lenders) is fairly straightforward. First, clarify how much funding you need and what you’ll use it for, then identify your non-negotiables, then go line by line in each of the venture debt term sheets you’ve received to compare apples-apples, then kick off the negotiation process ensuring that you engage legal counsel, and finally sign the term sheet that you’re content with. The single most important piece of advice we can share is to start the process early, particularly when you don’t need it. This will enable you to negotiate from a position of strength to secure the best terms.

Two other notes:

• 1) When you do draw from the facility, only pull what you need—having too much capital is almost as bad as not enough.
• 2) Remember that there are always other options out there, if you’re not comfortable with the terms or the underlying lender, do not sign on the dotted line.

We’re by no means legal professionals, and this guide is by no means legal advice, but if you’d like an extra set of eyes (or hands) reviewing your term sheets, or if you have additional questions we’d be happy to help out. Get in touch with us!

Happy Building!