A Startup Founders’ Guide to Raising Venture Debt in 2023

Given you’re reading this guide, we’re going to assume that you are either mid-raise or about to kick off a venture debt process. In either case, there are some things you should know—these tips will help you get the most out of your raise, so you can secure the ideal outcome for your startup. A few of the things we’ll cover: when to raise (and not to raise) venture debt, the ideal uses of venture debt (and in which scenarios other forms of debt financing are a better option), how to run a structured venture debt process, and more. Let’s dive in!

An overview of venture debt

Before we dive into the nuances of venture debt, we figured it’d be beneficial to discuss what venture debt is and isn’t. Venture debt is a form of term loan that typically has three characteristics: 1) monthly, interest-only payments; 2) a bullet structure, with principal repayment due at maturity; 3) mandated warrant coverage. Venture debt is a form of senior debt, that takes repayment precedence over subordinated debt in the event of a default. Venture debt is not typically non-dilutive, inexpensive, or easy to qualify for. Historically, venture debt was reserved for tier-one venture-backed companies, though that has changed in recent years with more bootstrapped companies qualifying for venture debt offerings. For a more in-depth look, check out the ultimate guide to venture debt in 2023.

When to raise venture debt

The most straightforward answer (and one you’ll hear most from founders and VCs) is as soon as possible following an equity raise. While we agree somewhat with this advice, the reality is that not all startups need venture debt (especially not after just closing a massive round), nor should the executive team be spending the time required to run a full-fledged venture debt process when they could be building, shipping code, and selling the product. That said, startups who can put the additional capital to work immediately and can adequately service the debt or those who have a line of sight into their next equity raise, should start the process before they need it, since most venture debt processes take ~3 months to complete. Check out this guide for a more in-depth look at the eligibility criteria and requirements for venture debt.

When not to raise venture debt

If you are in dire need of capital, pursuing venture debt is not going to end well. Similarly, if your startup’s cash flows cannot support the interest-only payments that venture debt facilities require or if your startup has highly variable revenues, you likely should not raise venture debt. Why? Because the last thing you want to have to happen is a cash crunch, where you miss the interest-only payment and are forced to prematurely pay back the principal balance. If that happens, and you don’t have adequate cash to cover the repayment, your entire company may get dragged under.

Strategic use cases of venture debt

Capital is like the tools in a carpenter's tool belt—there are different types, shapes, and sizes. In the same way, you shouldn’t use a hammer to put a screw in the wall, you don’t want to use the wrong kind of capital to fuel your growth. With venture debt in particular, there are a handful of scenarios when its the right “tool” for the job, these include: 1) as a bridge to the next equity raise; 2) as a cash cushion for cyclical businesses; 3) as a means to limit dilution and maintain control 4) as a means to invest in long-term business opportunities.

• Bridge loan: venture debt facilities can be used as a bridge between equity rounds, if the startup is close to achieving its targets, but needs a temporary boost to get there. While certainly not the most cost-effective capital option, if structured properly the total cost can be contained. For more information, check out the full guide we put together on bridge loans.
• Cash cushion: cyclical businesses by definition have swings in their cash flow which make it difficult to scale the business. This is because the planning process and capital outlay take place 3-6 months in advance of the revenue coming in. Venture debt can help solve this growing pain by providing the capital needed to continue growing the business.
• Equity preservation: equity capital inherently comes with dilution, venture debt does as well (warrants), however, the amount of dilution is significantly less. This means that typically founders can maintain more control, and the cost of capital is lower in a liquidity event.
• Strategic investments: startups must execute in the short term, and maintain a vision for the long term. This is challenging because some forms of capital must be paid back relatively quickly, and thus only short-term investments make sense e.g. hiring salespeople, launching marketing initiatives…etc. Venture debt, albeit not permanent capital, has a much longer payback period meaning startups can invest in long-term initiatives, such as R&D, which do not generate returns in the short term.

How long it takes to raise venture debt

Venture debt is a lot like equity capital in that there is a rather lengthy due diligence and negotiation process. Typically startups will pursue multiple venture debt providers and shop the resulting term sheets against one another. In most cases, the end-end process from the initial meeting to the funding hitting your bank account will take 8-10 weeks, though in 2023 we’re seeing venture debt processes frequently extend past the 12-week mark.

How to run a tight venture debt process

When raising venture debt, you’ll want to run a tight process. We’ve outlined several recommendations below based on the funding environment in 2023, this process may differ slightly depending on the prevailing market conditions.
 

1. Identify Business Need - before you approach any debt provider, make sure that you have a clear understanding of preciously what you intend to use the capital for and how much capital you’ll need to achieve said objective. Pro-tip: model out several scenarios and add in a buffer of at least 20%.
2. Select Target Providers - much like the process you ran when selecting target firms for your equity raise (e.g. reputation, portfolio, specialty…etc.) you’ll want to identify similar characteristics that you want to look for in a venture debt provider. One of the more important things to consider is how they’ll react to the potential downside scenario: will they work with you or will they hold your hands to the fire. Pro-tip: talk to founders who have raised venture debt and ask how they were treated by the various firms, then ask for referrals.
3. Nail the Screening - given you’ve raised equity, you know how the pitch process works, however, with venture debt providers it's much less about the then and there or the vision of where you want to head, and much more about the here and now. How much revenue are you generating? Are those revenue lines growing? What’s the revenue mix? What’s your monthly churn? What’s your burn and what’s your remaining runway? What’s your outstanding debt? What percent is senior vs subordinated? Pro-tip: know your numbers inside and out. Be prepared to explain preciously how much capital you are looking for, the specific use case of said capital, and what you’re looking for in a partner.
4. Term Sheet - if all goes well you’ll be given a term sheet. Hopefully multiple term sheets from various providers. If you get more than one, congrats, you now have leverage to pit the offers against one another. Start by heat mapping the key terms and covenants—if you don’t understand something or want to help structure the deal, now’s the time to bring in the legal team. Yes, it will be expensive but know that you’ll thank yourself later. Once you’ve identified the key terms you’re concerned with, negotiate them. Pro-tip: it's better to go with a 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 one that has a slightly lower headline cost of capital (interest rate, warrant coverage..etc.).
5. Due Diligence - This is the step that takes the longest to complete. Venture debt providers will want access to anything and everything they can get their hands on. Historical financial records, P&L statements, forward-looking projections, accounting data, billing & subscription data…etc. They may also ask to speak to your current customers, and perhaps even your investors. Pro-tip: to speed up this process, work on gathering and organizing all the necessary financial documents, and the prospective customer interviews ahead of time. 
6. Funding - Congrats! If you’ve gotten this far you’re almost there! The final step in the process is for the venture debt provider to process the wire. Don’t fumble the ball at the one-yard line by exponentially increasing your S&M spend, drastically increasing your headcount or anything else that would significantly impact your P&L. Pro-tip: just because you’re approved for $5M of venture debt doesn’t mean you should take it all—consider taking only what your startup needs, plus a slight buffer. 

Items to negotiate when raising venture debt

There are several items you can negotiate when raising venture debt, they include principal, fees, covenants, warrants, and default events. For more information (and a framework you can use), check out this guide on comparing and negotiating venture debt term sheets.

• Principal - this is the amount of money you are asking for. Again, refer back to your model, and add a buffer of 20-25% to determine how much capital your startup needs.
• Fees - venture debt providers will often try to get you to pay for their legal fees, as well as a host of other fees including origination fees, final payment fees, pre-payment fees, and more. These fees are pure margin, and most providers will reduce or eliminate these erroneous fees if pressed.
• Payment maturity & structure - the payment maturity date is the date when the facility matures and principal repayment is due. Typically this period is 24-36 months, but in some cases, it can even extend to 48 or 60 months. Most venture debt deals are structured with an interest-only payment period followed by a bullet payment at maturity, while others require partial monthly principal payments followed by a bullet payment at maturity (less common). 
• Covenants - these are loan conditions that must be complied with, to avoid a default on the loan (usually financial or performance related), as well as rights given to venture debt providers if said conditions are not met. The basic information like access to updated or real-time financials, headcount, current leases and subscriptions, outstanding accounts receivable..etc. should be provided. Occasionally providers might require that a percentage of the funding be held in an account at the institution, this too is relatively common. Things like veto rights or all asset liens or negative pledges on IP should be negotiated. Check out this guide for the venture debt covenants, clauses and provisions to avoid.
• Default events - these are the particular situations in which the loan is considered “in default”. Typically a default event only occurs in the event of multiple missed payments, but sometimes it can occur on the first missed payment or in other scenarios—so make sure to be very careful when negotiating these.

Typical market rates for venture debt

• Interest rates - banks typically charge the lowest amount, ranging from prime to prime + 1-4%, while other providers will charge prime + 5 - 9%+. 
• Duration - most venture debt deals mature in 3-4 years. 
• Closing fees - typically 1% of the principal amount.
• Origination fees - typically 1% of the principal amount.
• Warrants - banks typically require the lowest warrant coverage at 1-2%, while other funds will require 2-5%+.

Warrants in venture debt

Most venture debt deals come with required warrants, which give lenders the right, but not the obligation to purchase shares of your startup at a fixed price within a fixed period, usually one to twenty years. Typically this warrant coverage translates into a 1-2% stake in your startup, which can add significant cost if you exit at a high valuation.

That said, we’ve seen several venture debt deals in 2023 with double-digit warrant coverage, which implies that either the startups had exponentially higher risk profiles or the lenders had commensurately lower risk tolerances than typical market cycles. Given the collapse of SVB (the largest provider of venture debt to startups) earlier this year, the surviving lenders simply just aren’t willing to take on as much risk today.

If you are pursuing a venture debt raise, be prepared to negotiate. You likely will not be able to get low-single digital warrant coverage, so anything under 5% should be considered a win.

Common covenants you may come across

• Minimum revenue target: this covenant outlines the specific dollar amount of revenue that the startup must generate each quarter.
• Debt-to-equity ratio: this covenant specifies the maximum amount of debt that a startup can take on, concerning its equity. 
• Maximum loan-to-value ratio: this covenant requires the startup to maintain a particular upside valuation multiple compared to the outstanding debt.
• Negative pledge on IP: this covenant prevents startups from pledging their intellectual property to another party while the loan is outstanding.
• All asset lien: this covenant gives the provider the right to seize all of the assets of a startup, should they fail to make repayments. 
• Reporting requirement: this requires the startup to prepare and deliver audited financial statements to the venture debt provider consistently. 
• Primary banking relationship: this requires the startup to conduct all of its primary banking business with the lender.
• Investor abandonment clause: this gives the lender the right to determine whether or not a startup’s investors will continue to support them, and if not, then they can declare the loan in default.

Term definitions of a venture debt agreement

• Type - this specifies the category of financing the startup applied & is approved for.
• Amount - this specifies the total amount of capital available to the startup.
• Maturity date - this specifies the date on which the loan matures and principal repayment is required.
• Term loan availability - this is the period in which the startup can draw down / access the capital pledged to them. It is typically the same as the interest-only period.
• Interest only period - if applicable, this specifies the period in which the startup can draw down or access the funds and only interest payments are required. Typically this ranges from 12-18 months, on a 36 - 48 month facility.
• Interest rate - this is the rate you pay on the outstanding principal balance of the venture debt facility over the life of the loan.
• Interest payment dates - this is when the interest-only payment is due each month.
• Amortization schedule - this outlines when principal repayments begin, assuming there is no bullet payment upon maturity.
• Milestone event - this usually refers to a specific revenue milestone, that once achieved satisfies a particular stipulation of the deal, such as unlocking a second tranche of funding. Milestones are used to bridge the gap between a startup’s desires and the lender’s appetite for meeting those desires.

Factors to evaluate when selecting a venture debt provider

When evaluating venture debt providers, there are several factors you should consider. The main thing you’ll want to understand is how flexible the provider is, and how they will act through-cycle. In bull markets venture debt providers will fight to push deals through, and will be much more willing to hash out the details. During bear markets, like we’ve experienced throughout 2022 and now 2023, venture debt providers’ true colors shine: some will work with the startups to restructure the terms of the deal, and others will hold their feet to the fire and force them to prematurely repay the principal. You want to find partners, that act in the former.

A few of the other factors you’ll want to consider:

• The provider’s reputation and track record of executing deals in your space
• The provider’s ability to scale its capital facilities as you grow
• The provider’s ability to offer competitive terms
• The timeliness of the provider: how quickly they can process your application and complete the due diligence cycle 
• The non-monetary benefits of working with the provider: introductions to investors, partners, and potential customers, and their willingness to provide additional support and resources

You can think of your relationship with venture debt providers, in the same light as the partner you decide to marry someday. You’ll want to work with a provider who will be there for you during the good times and the bad. A provider that understands what you’re building, and shares similar values. A provider that respects your decisions and ultimately trusts you to execute your vision of the future. The reality is that you’ll be tied to this lender throughout the entirety of your startup’s existence (especially if they have high warrant coverage), so you’ll want to pick the right provider the first time.

Top venture debt providers for startups

According to TechCrunch, the world's largest venture debt provider for startups was Silicon Valley Bank, before it collapsed in March 2023. Since then, several banks have been vying for the coveted position, but none have risen to the top, resulting in venture debt deals being down 38% YoY. Other top providers of venture debt include banks, venture capital firms, and other specialized lending institutions, though Neobanks and Fintechs are quickly catching up.

Tips for closing your first venture debt facility

This is by no means an exhaustive list, just some of the things we learned firsthand by raising a venture debt facility of our own.

• Start early, particularly in this market - remember, just because you qualify for and are approved for venture debt does not mean that you need to take it immediately. You have the entire term loan availability period to draw it down, assuming there are no material changes to your business. As they say, it's better to be safe than sorry.
• Run a process - we outlined what a tight venture debt process looks like above, re-read that section if you’re unsure where to begin. The single most important thing you can do is get two term sheets, once you have those you can negotiate from a position of strength. 
• Prioritize key terms and negotiate them early - most first-time founders focus exclusively on the headline numbers: principal, maturity, interest, and warrants. While those factors certainly are important, the most important factor should be the covenants and terms of the deal, which can significantly impact the day-day operations of your startup.
• Compare apples to apples - remember the true cost of capital is more than just the headline interest rate, it's also the warrants, fees, legal, and investor rights that come along with the facility. Consider these factors as well when comparing various term sheets.
• Know who you’re marrying - as with all forms of permanent capital, you’ll want to have a deep appreciation for who you’re going to work with and trust that they’ll take your interests into consideration when making decisions. Make sure to choose the right partner.

Final thoughts on raising venture debt in 2023

While 2023 has certainly been a challenging funding environment for founders and capital markets teams, venture debt deals are still being done. The startups that are having the most success, have strong financial performance, a clear understanding of their capital requirements, and have been flexible with their expectations around timeline, sizing, and terms. Running a tight venture debt process is by no means easy, but it's unequivocally worthwhile.

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’d like introductions to venture debt providers, we’d be happy to help out. 

Happy Building!