Deposits are an important part of venture debt. It’s normal for part of the deal to require you send the lender, say, $20,000-$30,000. So why are deposits required by your lender when you sign a venture debt term sheet?
There are two key reasons for your lender to ask for this deposit:
Skin in the game – why ask for a venture debt deposit
The first function your deposit has is ensuring that you have some ‘skin in the game.’ Your lender wants you to have some measure of investment so that you don’t walk out on a term sheet. For example, you could sign a term sheet but then never return their emails or calls.
Remember, they are going to be spending money and time doing due diligence, tying up all of the administration and organizing documentation. It may sound obvious but, at this point, they really don’t want you to either run away or shop around for a better offer. Your deposit helps to guarantee your commitment to the deal.
Offsetting expenses
The second reason a venture debt lender will ask for a deposit is to collect money to offset the expenses that we just mentioned:
- Due diligence
- Administrative costs
- Documentation fees
Fundamentally, lenders don’t want to have to pay for the legal costs themselves. They want the company they’re lending money to to pay for the legal costs.
That means that the deposit will almost always be applied to the legal costs. Therefore, it’s a good idea to try to cap your legal fees when you do a debt deal. Set a budget of $15,000-20,000 depending on the circumstances – there will be many deals that are far more convoluted, but this is a good figure to start with.
Venture Debt Deals Differ in Complexity
Series A and Series B venture debt deals generally aren’t that complicated. However, you must always make sure you ask for a cap on the deposit, something reasonable, to ensure it doesn’t get out of control. Especially when times are tough.
In an ideal world the deposit will equal the cap. That way you’re not going to be out of pocket if something gets difficult. Ultimately, it comes down to lenders not wanting to have to pay for expenses themselves. They want you to pay for it, which is understandable.
Always Ask For Accounting Statements
Our final note on this topic is that you should try and remember to always ask for an accounting statement after the deal is done. Often, you’ll find that the deal only costs around $10,000 to document and you’ve paid $20,000, so therefore you’re due $10,000 back.
Asking for an accounting statement is an easy way to get the money you are owed back. Furthermore, it’s just good practice to always have accounting statements to back up any kind of expenses.
If you have any other questions on venture debt, valuations, startup investing, startup accounting, or taxes please contact us.
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