Ten Questions Every Founder

Should Ask before Raising

Venture Debt
Brian Feinstein, Craig Netterfield, and Allen Miller
There's an adage that says your first job as a startup CEO is to make sure your company
never runs out of cash. But when financing a growing company, venture debt can be a great
supplement to venture capital and in some cases may be a necessity. Much has been written
to help founders think through venture capital, but venture debt remains a bit of a black box.
That's why we partnered with our friends at http://www.clpgrowth.com/
Columbia Lake Partners, a leading European
venture debt fund, to put together a white paper that helps startups approach venture debt
in a thoughtful way.

For those of you short on time, below is a summary. And for the finance geeks among you,
we’ve put together a https://bvp.box.com/BVPVentureDebtModel
Venture Debt Model for you to assess the true cost of venture debt.
https://bvp.box.com/BVPVentureDebtModel

SUMMARY

Why venture debt? raised $10 million of equity but think you may
Venture debt refers to a variety of debt need $15 million to get to the next major
financing products for venture-backed milestone)
companies. Typically, venture debt is b) Preventing the need for a bridge round or
provided by banks or dedicated venture debt a down round to get through a tough period
funds as a complement to equity financing. It without creating a negative signal
can act as an attractive way to finance a c) Funding large capital expenses,
business with less dilution than equity and acquisitions, or acting as a bridge to
does not require a valuation to be set for the profitability
business. Additionally, venture lenders don’t d) Acting as insurance in case it takes longer
take board seats and have few governance than expected to hit the next milestone
requirements. But like any loan, venture debt
needs to be repaid with interest over time. Most companies raise venture debt
immediately following an equity financing,
When should I raise venture debt? when it is often easily accessible, your
There is no “one size fits all” approach to investors are optimistic, all of your diligence
venture debt, but there are five common use materials are fresh and readily available, and
cases: you have momentum.
a) Extending the cash runway of a business to
hit the company’s next milestone (e.g. you’ve

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When should I avoid venture debt? What is considered "market" for these
It’s a bad idea to use venture debt if any of terms?
the following apply:
Term Market Rate
a) You don’t think you can repay the debt
b) The terms or covenants are too onerous Interest Rate Banks: prime + 0-4%.
Funds: prime + 5-9%
c) Your venture investors are not supportive
Duration 3-4 years
To make the venture loan more economically
Amortization Within 12 months of when a loan
sound, we recommend delaying the time
is drawn down
when you draw down the loan. This will in
turn delay the time when you have to start
Closing Fees 0%-1%
repaying the loan, which extends your runway
and reduces the actual cost of the debt. Warrants Banks: <1% dilution.
Funds: ~1% dilution.
We’ve created a handy https://bvp.box.com/BVPVentureDebtModel
Venture Debt Model to
https://bvp.box.com/BVPVentureDebtModel

help you assess the effective cost of venture

debt. How should I react to covenants?
Non-financial covenants are common. Be
What terms should I be thinking about cautious around financial covenants, which
when raising venture debt? act as financial tests that must be met or else
Here are the key things to consider: your company may be in default.
a) The size of the loan
b) The duration of the loan What happens if I can't repay the
(when does it need to be repaid?) loan?
c) The price of the loan When the time comes to repay the venture
(what are the fees and interest rate?) loan, you have three options:
d) The covenants a) Repaying:
(what are the financial and non-financial You use cash on your balance sheet or equity
covenants?) from investors to pay it back.
e) Timing of the amortization b) Refinancing:
(when do we start repaying the loan?) You find another lender who will refinance
the loan.
Banks will have the lowest rates, so first talk c) Restructuring:
to banks and then approach venture debt You try to negotiate a more favorable
funds if you want additional capital. repayment plan with the lender.

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If things are going well, repayment or What's the best way to run a venture
refinancing is easy. But if your company is in debt fundraising process?
trouble, you will need to work with your Much like the venture capital world, you need
lender to restructure the debt and avoid to talk to a number of different banks and
foreclosure. venture debt funds to get a better feel for
how much capital is available. We strongly
How do I decide which venture recommend engaging a venture lawyer who
lenders to work with? has worked on a large number of recent
The most important thing to research when venture debt deals who will be able to advise
choosing a lender is how they’ve behaved in you on getting the best possible terms. And
the past. In the event that things go south, just as you would with an equity round, make
you want a lender who will work with you to sure you have a few horses in the race so you
restructure the loan. You should conduct can negotiate the best terms.
reference calls on the lender to see how
they’ve behaved in tough times. Venture debt won’t be the right fit for all
companies, but if structured properly, it can
What is the venture lender's typical be a less dilutive way for you to finance your
diligence process? journey to the next milestone.
Venture loan diligence resembles the venture
capital diligence process, although less
intense. Be prepared to provide much of the
same information you provided in your
venture capital raise.

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THE FULL PICTURE

Why venture debt? structured as three year loans, which

Venture debt refers to a variety of debt amortize (get repaid) over time. The lender
financing products for venture-backed typically gets quarterly cash interest
companies. Typically, venture debt is payments, some cash fees upfront, and
provided by banks or dedicated venture debt warrants for company stock (options to buy
funds as a complement to equity financing. It stock in the future at the current price). Term
can be a useful supplement to equity by loans are usually senior debt, meaning that
allowing companies to extend their cash they are repaid first in an exit or bankruptcy
runway and get to their next milestone. and are collateralized by a company's assets.
Venture debt can result in less dilution for Both banks and venture debt funds issue
existing shareholders and does not require a term loans.
valuation to be set for the business.
Additionally, venture lenders don’t take board Venture debt can also refer to another
seats and have few governance requirements. category of debt products called revolving
lines of credit (or revolvers). Unlike a term
There are also some downsides to venture loan, which is a lump sum of cash, the
debt (when compared to equity). A venture revolver functions like a credit card through
loan creates a cash expense for the company which you can borrow (“draw down”) up to a
every quarter. Unlike equity, it needs to be certain limit. For example, the most common
repaid or refinanced at some point in the type of a revolver is an accounts receivable
future. If the loan is not repaid, the venture revolver which allows you to borrow money
lender can take over the company’s assets. based on the amount of account receivables
Furthermore, if venture debt is not on your balance sheet. In addition to
negotiated properly, it can be very expensive accounts receivables-based revolvers,
or restrictive to a founder’s ability to make recurring revenue software businesses can
decisions. That being said, if used correctly, take advantage of a new type of revolver that
venture debt can be a helpful financing tool is tied to a company’s recurring revenue
to companies at any stage. (more info here). Revolvers are typically
http://www.clpgrowth.com/our-blog/2015/2/7/types-of-debt-the-mrr-line
http://www.clpgrowth.com/our-blog/2015/2/7/types-of-debt-the-mrr-line
http://www.clpgrowth.com/our-blog/2015/2/7/types-of-debt-the-mrr-line

provided by banks, whereas venture debt

The main types of venture debt products are funds tend to focus on term loans.
term loans, provided by both banks and
funds, and revolvers, provided by banks.
Venture term loans are most commonly

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When should I raise venture debt? • To avoid setting a valuation (in the event of
Like in venture capital, there is no “one size a down round).
fits all” in venture debt. Here are some If your business has been underperforming
situations when it may make sense to finance or market conditions have changed and you
your company using venture debt: are concerned that your next round of capital
would result in a disruptive down round,
• To extend the cash runway of a business. venture debt can be a way to finance your
If you have raised a $10M equity round but business without having to set a valuation.
believe you need $15M to get to the next
milestone in your business, venture debt can • Funding to profitability.
provide the remaining capital without If your company is approaching profitability,
increasing dilution. venture debt can be a way of reaching the
promised land without incurring additional
• As an insurance policy. dilution from equity.
You may want some extra cash as a cushion
in the event that your company needs more Most companies raise venture debt
time to get to its next milestone. For SaaS immediately following an equity financing.
businesses, an MRR revolver can be a You’ve got momentum, your investors are
particularly cheap form of insurance. optimistic, and all of your diligence materials
are fresh and readily available. This tends to
• To prevent the need for a bridge round. be a time when venture debt is easily
Raising a bridge round from your existing accessible.
investors can be expensive and send a bad
signal to prospective investors. Venture debt However, the main downside to drawing debt
can act as a bridge to where you need to go immediately is that you will be paying down
without the pain of a VC-led bridge round. the debt for a long period before you can
actually use the cash. This means that by the
• To fund large capital expenses, an time you touch the cash from the venture
acquisition, or interim cash needs. debt, you’ve already repaid much of it.
Venture debt can be used as a cheaper Instead of getting $5M of extra cash runway,
alternative to equity to fund acquisitions or you’re actually getting $4M of additional cash
purchases of equipment. It can also fund new runway if you’ve already repaid 20% by the
growth initiatives that require an amount of time you start using the venture debt. This
capital too small for an equity round. means that the actual cost of the loan is
higher than the headline interest rate since
you’re paying interest that is calculated off

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 a $5M loan on what is effectively only $4M of debt funds for additional capital.
extra cash. (For a detailed breakdown, see
Sarah Tavel’s posts on the topic here and Much like the venture capital world, you need
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html

here.) to talk to a number of different banks and

http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html

venture debt funds to get a better feel for

To make the venture loan economically how much capital is available. We also
sound, we recommend delaying the draw strongly recommend engaging a venture
down period (the time when you actually get lawyer who has worked on a large number of
the funds) as much as possible. This means recent venture debt deals and will be able to
that you will delay the time when you begin advise you on getting the best possible
paying interest and principal, which extends terms.
your runway and reduces the actual cost of
the debt. Your ability to delay the draw will When should I avoid venture debt?
depend on the strength of your company and Generally speaking, there are a few situations
the competitiveness of the venture debt when it is a bad idea to use venture debt:
process. If you’ve got a good business with
strong VCs, you can typically get 6-12 months. 1. If you don’t think you can repay it.
If you are unable to delay the draw down If your company is performing poorly and you
period, consider pushing for a 6-12 month don’t think you’ll be able to raise more equity
interest-only period during which time you in the future, you should avoid venture debt.
don’t have to repay the loan. To put some Venture lenders have a right to take over your
rigor behind this analysis, we’ve assembled a business if they are not repaid. You should
Venture Debt Model for you to assess the
https://bvp.box.com/BVPVentureDebtModel
https://bvp.box.com/BVPVentureDebtModel only raise venture debt if you believe your
true cost of venture debt (and compare existing investors or an outside investor will
against your equity options). invest more equity in the future to repay the
loan.
When deciding between debt products, our
recommendation is that you start with the 2. When the loan amortizes immediately.
cheapest form of venture debt and then work As discussed, if you’ve raised lots of cash
your way over to more expensive forms. from equity, you want to delay when you
Banks have a lower cost of capital than draw down the debt because otherwise you’ll
venture debt funds but are typically end up repaying a significant portion of the
constrained by the amount that they can loan before you can even use the money. This
lend. So you should start by talking to banks makes the effective cost of debt is much
about their revolving line of credit and term higher than meets the eye.
loan options, and then approaching venture

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3. When the terms or covenants are too What terms should I be thinking about
onerous. when raising venture debt?
It’s critical that you have someone on your Venture debt speaks a different language
team who can model the cost of the debt and than venture capital. Our most important
understand the impact of any covenants on recommendation is that you hire a lawyer
your business to make sure you aren’t signing who has experience negotiating venture debt
up for anything you can’t handle. deals. They can give you valuable context on
what is “market” and help you zero in on the
4. When your investors are not supportive. important terms.
Generally speaking, your VCs should be fine
with venture debt if you make a compelling Generally speaking, the five most important
case for how the additional runway will areas to consider include:
benefit the business. But if you have
investors who are allergic to venture debt, • Size of the loan (the actual dollar amount
you should avoid it because it will be tough you will receive)
to attract venture lenders if they think your • Duration of the loan (how long until the
investors will be tough to work with. loan must be paid back)
• Price of the loan (the fees and interest you
Some of our founders have asked us if must pay the lender)
venture debt has any negative impact on • Timing of amortization (when do you have
future fundraising. Any VC who wants to to start paying back the loan?)
invest in your company will do so, regardless • Covenants (what behavior could trigger a
of whether or not you have venture debt on loan default?)
your balance sheet. They may be slightly
annoyed about the fact that part of their It’s important to point out that the price of
investment will go toward repaying debt, but the loan is not just the interest payment.
we haven’t encountered any situations where Lenders will use fees to increase the cost of
a VC has declined to invest because of the loan. To approximate the price of the
venture debt. loan, take the fees, divide them by the
duration of the loan, and add it to the
interest rate. So if you have a three year term
loan with a 1.5% origination fee and 11%
interest, the actual price of the loan is about
11.5%.

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The table below outlines the typical fees you What is considered “market” for these
may see: terms?
The table below provides a rough range for
Fee Type Explanation
what we’ve seen in the market for these types
Origination Generally 1-2% of the full loan of deals. Where you fall within these ranges
amount at origination.
will depend to a large extent on market
Prepayment Fee for paying a loan back early. conditions and the specifics of your business.
Waiver / A penalty if a company Term Market Rate
Default underperforms or breaches a
covenant and is in default. Interest Rate Banks: prime1 + 0-4%.
Funds: prime + 5-9%

Venture lenders make their near-term returns Duration 3-4 years

through fees and interest payments but their
long-term upside from warrants. Warrants are Amortization Usually begins 0-12 months after
the loan is drawn down (funds are
the same as options. They provide the lender
received)
with a contractual right to buy stock in your
Closing Fees 0%-1%
company at a future point in time. Lenders
typically describe warrants in terms of Warrants Banks: <1% dilution. Funds: ~1%
warrant coverage. If a $1M venture loan dilution.

comes with 10% warrant coverage, this means 1 The interest rate that commercial banks charge their
that the lender has the option to buy $100K most credit-worthy customers. The prime interest rate
is largely determined by the federal funds rate, which
in equity at some point down the line, usually
is the overnight rate which banks lend to one another.
within the next 7-10 years, at an agreed upon
exercise price (also known as a “strike price”.)
This exercise price is usually set at the price
per share of the most recent equity financing.
Warrants are typically exercised at exit. If
your company has a value at exit that is
greater than the value of the exercise price,
the lender will exercise the warrants at and
capitalize on the difference between the
exercise price and the price at exit.

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How should I react to covenants? What happens if I can’t repay the
Most venture debt deals include a variety of loan?
covenants. Non-financial covenants describe When it is time to repay the venture loan, you
situations where the lender needs to provide have a few options:
approval. This typically includes things like
issuing dividends, selling the company, • Repayment:
licensing IP, making acquisitions, etc. If you You can use cash on your balance sheet or
make one of these decisions without the equity from investors to pay it back.
lender’s approval, this is called breaching a
covenant. If you breach a covenant, you are in • Refinancing:
default. Sometimes you may encounter You can find another lender who will
financial covenants. These are financial tests refinance the loan—essentially giving you a
that must be met. For example, the lender new loan to repay the existing loan.
may require that you hit a certain revenue
target or maintain a certain cash balance. If • Restructuring:
you breach these financial covenants, then You can try to negotiate a more favorable
your company is in default. repayment plan with the lender.

Typically, venture debt deals do not have When things are going well, you should not
financial covenants because startups are have any problems repaying a venture loan.
unpredictable and need to be able to operate You can either raise more equity to continue
flexibly. Financial covenants are more paying down the loan or you can refinance
common in later stage companies where with a new lender.
there is more financial stability and
predictability. But if you’re unable to raise equity or
refinance, you are at risk of default. While the
Default results in additional fees and lender has the right to foreclose and sell off
penalties. It also means that the lender has your company’s assets, venture lenders
the right to foreclose or take possession of typically like to avoid this. They can usually
your company and sell off its assets. In do a better job recovering their loan if the
practice, lenders view foreclosure as a last company continues to operate. Instead, they
resort. But the additional fees and threat of will try to work with you and your investors to
foreclosure prevent borrowers from willfully change the terms of the loan to provide some
breaching covenants. relief to the company—also known as a
restructuring.

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There are many different ways that capital since part of the loan amount is
restructurings play out. For example, the funded using low-cost bank debt.
lender may ease up on amortization so you
have more cash runway to develop the What is the venture lender’s typical
business. But they may charge additional diligence process?
fees and require that your investors invest For venture lenders the most important
more money into the company. question is—“will your company continue to
be able to raise more venture capital?” This
Usually restructuring becomes a three-way means that their loan will be repaid in the
conversation between the VCs, lender and future. As a result, the venture lender
entrepreneur. It’s during these times when diligence process resembles the venture
having the right lender is critical. You want to capital diligence process as the lenders try to
choose a lender that has reputation for look at the business through a VC’s eyes.
working with founders in a constructive way
during tough times. The specific pricing and terms of the loan will
depend on both external and internal factors.
How do I decide which venture Macroeconomic conditions at the time you
lenders to work with? raise the debt are critical. All things being
As discussed, venture lenders can behave equal, a faster growing company will get
very differently when things start going better terms. A company with better-known
sideways and you need to restructure your VCs will get better terms. A company that has
loan. When choosing a lender, you need to more predictable revenue will get more
research how they’ve behaved in the past in favorable terms. But as in a venture capital
difficult situations. You should conduct financing, it all comes down to getting the
reference calls on the lender with VCs and lenders to believe in you and your business.
companies they’ve worked with—especially
the ones that have gone through
restructurings.

Generally speaking, you should start with the

banks because they are cheaper. However,
banks are typically limited in the loan size. In
some cases, it may make sense to raise the
debt from both a bank and a fund. This
allows you to achieve a lower blended cost of

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What’s the best way to run a venture • As you narrow the pool of options, conduct
debt fundraising process? further diligence on the lenders. Ask the
lender to connect you with companies where
• Ask your investors to provide you with they had a default or restructuring to
introductions to lenders. Start with banks understand how they behave when times are
then move on to venture debt funds for more tough.
capital.
• Make a final decision. Once a term sheet is
• During the initial calls, provide lenders with signed, the venture lender will send over full
an overview of your business and a demo of loan documents. It is recommended that you
your product. work with a lawyer that has venture debt
experience to review the documents.
• Provide interested lenders with diligence
materials. Encourage these lenders to talk to
your investors to get more conviction that
you will be able to raise more venture capital
in the future.

• Wait for the term sheets to come in—with

any luck, you’ll have a few options to look at.

• Weigh the pros and cons of each term

sheet with your investors, provide counter
proposals and enter in the process of
negotiating on key terms. Be transparent with
each lender about what it will take to win
your business—they won’t be offended.

We’ve covered the basics in this white paper. If you have any thoughts or questions, email the
authors at brian@bvp.com and craig@clpgrowth.com.

And check out the Columbia Lake Partners’ blog for a more detailed series of posts on all
http://www.clpgrowth.com/our-blog/
things venture debt.

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APPENDIX A:
Active Venture Lenders in the US and Europe

Geographic Institution
Lender Type Link
Focus
Silicon Valley Bank United States Bank http://www.svb.com/
Comerica United States Bank https://www.comerica.com/
City National Bank United States Bank https://www.cnb.com/
Square One Bank United States Bank https://www.square1financial.com/
Eastward United States Fund http://www.eastwardcp.com/
Escalate United States Fund http://www.escalatecapital.com/
Gold Hill United States Fund http://www.goldhillcapital.com/
Hercules United States Fund http://www.htgc.com/
Horizon United States Fund http://www.horizontechfinance.com/
Lighthouse United States Fund http://www.lcpartners.com/
MMVF United States Fund http://mmvf.com/
NXT United States Fund http://www.nxtcapital.com/
ORIX United States Fund http://www.orix.com/
TriplePoint United States Fund http://www.tpt.com/
Wellington United States Fund http://www.wellingtonfund.com
WTI United States Fund http://www.westerntech.com/
Silicon Valley Bank Europe Bank http://www.svb.com/
Barclays Bank Europe Bank http://www.barclays.com/
Columbia Lake Partners Europe Fund http://www.clpgrowth.com/
Kreos Europe Fund http://www.kreoscapital.com/
Harbert Europe Fund http://www.harbert.net/

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APPENDIX B:
Other Helpful Resources

Bessemer Venture Partners’ venture debt model:

https://bvp.box.com/BVPVentureDebtModel

Columbia Lake Partners’ venture debt blog:

http://www.clpgrowth.com/our-blog/

Sarah Tavel’s two part series on venture debt:

http://www.adventurista.com/2009/01/true-cost-of-venture-debt.html
http://www.adventurista.com/2009/01/true-cost-of-venture-debt-part-ii.html

Leader Ventures’ overview of venture debt:

http://leaderventures.com/overview.pdf

Latham & Watkins on venture debt:

www.lw.com/thoughtLeadership/key-terms-to-address-at-term-sheet-stage-in-venture-funding

Kauffman Fellows piece on venture debt:

http://www.kauffmanfellows.org/journal_posts/venture-debt-a-capital-idea-for-startups/

Fred Wilson’s thoughts on venture debt:

http://avc.com/2011/07/financings-options-venture-debt/

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