How to Navigate Venture Debt

Greg Lyon


Mar 12, 2024



Eclipse Partner and CFO Greg Lyon debunks common misconceptions to help you determine if it’s the right choice for your startup.

A year ago, Silicon Valley Bank's (SVB) sudden collapse served as a stark reminder: effective capital management is of paramount priority for businesses of all sizes. Understanding where your capital is and the types of capital accessible to you is essential for any startup.

One emerging trend in the aftermath of the SVB crash is the increased competition in the venture debt market, as new players seize the opportunity to gain market share. This, coupled with a downturn in venture investing and a stagnant equity environment, have fueled an unprecedented level of demand for venture debt. 

Venture debt can be invaluable for startups, helping early-stage firms reach milestones and later-stage companies secure capital while managing cash flow. But it’s not a universal fix. Many founders misconstrue venture debt as “free money,” but it's more nuanced than standard equity fundraising that founders are used to. Unlike equity, debt demands repayment with interest and includes other restrictions. Despite more lenders participating, there’s less capital deployed because of higher interest rates and lower risk appetite, can make venture debt pricier than expected.

Many founders misconstrue venture debt as 'free money,' but it's more nuanced than standard equity fundraising that founders are used to.

Before taking on venture debt, startups should thoroughly assess its advantages and disadvantages and negotiate strategically.

What is venture debt?

Venture debt is a form of financing specifically designed for early-stage, high-growth companies backed by venture capital. Unlike traditional bank loans, it focuses less on current profitability or collateral and more on the company's potential for future success and ability to raise additional capital. In other words, it helps startups preserve equity after an early-stage equity round while securing funds for growth.

How do founders typically use venture debt?

There is no “one size fits all” approach to venture debt, but typical use cases include: extending the cash runway of a business to hit the company’s next milestone; funding large capital expenses, acquisitions, or providing a bridge to profitability; and acting as insurance in case it takes longer than expected to execute on the company’s plan.

Here’s a breakdown of how it’s typically used based on startup stage:

What are the pros and cons of venture debt? 

What questions to ask before considering venture debt?

  • How will you utilize and repay the capital, considering draw and repayment periods?
  • How much funding is needed, and how will repayment and interest cost impact cash flow and overall company expenses?
  • Do founders have 100% visibility into loan repayment through cash flows or future financing?
  • Are cash flows from revenue and other assets adequate to cover the loan throughout its repayment period?
  • What is the debt's purpose and its impact on milestones or fundraising efforts, including potential barriers to future financing?
    • Will the debt hinder raising the next round of financing, given a significant increase in valuation or funding requirements?
    • Will the debt hinder entry to the next round if a significant portion must be immediately allocated?

Is venture debt a good option for struggling companies?

No, venture debt is meant for financially healthy companies. Struggling startups should steer clear of it, as it worsens their situation. Venture debt lenders are less lenient and may become nervous if a company is struggling and its debt surpasses its cash reserves. Moreover, most venture debt agreements include a Material Adverse Change Clause, which allows banks to declare default right away, possibly resulting in the seizure of a startup's cash. Lastly, if a company goes bankrupt, venture debt holders sit above equity holders in the capital structure so they will be prioritized in any restructuring process possibly leaving equity holders with nothing.

What areas should you focus on during extended term negotiation?

Negotiating venture debt facility terms requires a holistic view. Lenders will often view these terms as different levers they can pull, which will affect their own internal threshold for returns. A great rate, for instance, might lead to higher backend costs, resulting in overall increased expenses. 

Don't negotiate for the sake of it; assess savings and priorities across all negotiation fronts. Here's a guide to key areas to consider:

Final thoughts

Venture debt is a useful and important financial tool. However, founders and startups should approach it with caution, taking the time to deeply understand both its benefits and long-term implications. While it may seem like a quick runway extension, working closely with a CFO to analyze capital usage, timing, and costs is critical for making informed decisions. We hope this guide facilitates helpful conversations before you take on debt financing.

If you're in the decision-making process now, here's a template to help you evaluate venture debt term sheets.

Download Evaluation Template

Reach out to Greg Lyon if you're building a startup in the intersection of physical and digital industries and have further questions about debt financing.

Follow Eclipse on LinkedIn for the latest on the Industrial Evolution.

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