What is Venture Debt?
Venture debt is a type of loan offered by banks and nonbank lenders that is designed specifically for early-stage, high-growth companies with venture capital backing. The first rule of venture debt is that it follows equity; it doesn’t replace it. Venture lenders use venture capital support as a source of validation and the primary yardstick for underwriting a loan.
Venture debt availability and terms are always contextual. Loan types and sizes vary significantly based on the scale of your business, the quality and quantity of equity raised to date, and the objective for which the debt is being raised. The amount of venture debt available is calibrated to the amount of equity the company has raised, with loan sizes varying between 25% and 50% of the amount raised in the most recent equity round. Early-stage loans to pre-revenue or product validation companies are much smaller than loans available to later-stage companies in expansion mode.
What are the use cases for Venture Debt?
- To fund value-enhancing transactions, such as acquisitions, specific projects or large capital expenditures
- To accelerate growth with low-cost and less dilutive capital
- To persevere a tough period without setting an unattractive valuation, or raising a downround, both of which sends negative signals
- To act as an insurance policy or provide a buffer against operational glitches or fundraising hiccups
- To extend runway to hit milestones for further fundraising at a higher valuation
How does a Venture Debt Process look like?
1) Intro & Investment Screening
- Review of business model, team, financing structure and VC investors
2) NDA & Pre-Due-Diligence
- After signing an NDA, financial data is disclosed so the venture debt provider can start a first pre-due-diligence
3) Term Sheet
- The term sheet contains all relevant information that will later on be translated in the final contracts
4) Due Diligence
- During the Due Diligence, the venture debt provider checks the financial, operational, legal situation of the borrower
5) Investment Approval
- Once the Due Diligence was successful, the investor committee of the startup and the investment committee of the venture debt provider have to approve the investment again.
6) Legal Review
- After the approval from both sides, the contracts are negotiated.
7) Release of funds
- After the contracts have been signed from both sides, the funds can be transferred to the startup.
What are typical Venture Debt Terms?
The structure and terms vary based on the assessment of credit risk which are driven by investment stage, business model, company performance, cap table quality, etc. Some companies are better positioned for venture debt financing than others, thus can negotiate more favorable terms or lower loan costs. For example, companies with recurring-revenue models are much more attractive to lenders than those with one-time revenue models. Likewise, companies with an entrepreneurial customer base and long-term contracts are less risky investments than companies in a consumer marketplace with high churn. Other factors are listed below: