When negotiating venture debt, startups typically focus on key terms, including interest rates, warrants, and covenants. But there’s one clause that can quietly put your entire company at risk: the Material Adverse Change (MAC) clause. At Kruze Consulting, we’ve seen firsthand how his provision can affect venture-backed startups.
What Is a Material Adverse Change (MAC) Clause?
A MAC clause gives the lender broad power to declare a default if they believe there’s been a “material adverse change” in your business, financial condition, or even the broader business environment. The problem? The definition is often vague and open to interpretation, allowing lenders considerable discretion in determining what constitutes a “material” change.
Why Should Founders Be Careful About MACs?
There are a lot of reasons that founders should consider MACs very carefully:
- Ambiguity favors the lender. Because the term “material adverse change” is not precisely defined, lenders can cite almost any negative development – real or perceived – as a reason to call a default.
- A default puts the lender in charge. Once you’re in default, the lender controls the situation. They can demand immediate repayment, force you to accept new terms, or even push the company toward liquidation.
- Some conditions are outside your control. MAC clauses can be triggered by changes in your business, the market, or even the overall economy – factors that are often outside your control.
- You lose negotiation leverage. After a default, your negotiating power is significantly reduced. The lender can dictate terms, and you must comply; otherwise, you risk losing your company.
Funding MACs: The Lender’s “Get Out of Jail Free” Card
While a MAC as an event of default can be a problem for your startup, an equally risky provision is the funding MAC. This clause, often hidden in the fine print at the bottom of the venture debt term sheet, gives the lender the right to withhold advancing additional funds if they determine that a material adverse change has occurred. If your startup is not performing as expected, the lender can use this clause as an excuse to stop funding future tranches of your loan, even if you’ve been counting on that capital for your growth plans.
If the lender pulls out due to a funding MAC, your company could suddenly find itself in a very tough financial situation, scrambling for alternatives. The funding MAC is essentially the lender’s “get out of jail free” card, letting them avoid further risk at your expense.
How Could MACs Affect Your Startup?
Imagine your startup faces a sudden market downturn or loses a major customer. Even if you’re still fundamentally healthy, a lender could claim this is a “material adverse change” and declare you in default, or refuse to advance the next tranche of your loan due to a funding MAC. Now, you’re forced to play by their rules – whether that means paying down the loan early, accepting punitive terms, or worse.
How to Protect Your Startup
When you’re negotiating a venture debt loan, make sure you work with an experienced startup attorney, and always compare multiple term sheets to get the most founder-friendly terms. Some specific actions you can take include:
- Avoid MAC clauses entirely. The best protection is to exclude MAC clauses from your term sheet. Push back if a lender insists on including one.
- Define MACs narrowly. If you can’t avoid a MAC clause, work with your counsel to define it as narrowly and specifically as possible. Limit it to truly catastrophic events, and negotiate carve-outs that exclude general market or industry downturns.
- Draw all the money upfront. If you can’t strike a funding MAC out of your term sheet, consider drawing all the money upfront so you never have to worry about the lender refusing to fund later tranches.
- Stay in compliance. Always monitor your financial and operational covenants closely to avoid any risk of default.
MACs Can Be Risky
A MAC clause is like a hidden trapdoor in your venture debt agreement. Its ambiguity gives lenders sweeping power to declare a default, putting your startup at risk of liquidation or forced repayment. If you need help reviewing your venture debt term sheet, reach out to Kruze Consulting.
