Venture debt can be a powerful tool for startups – extending runway, reducing dilution, and adding flexibility between fundraising rounds. But like all financial instruments, venture loans come with strings attached. Chief among them are events of default, clauses that give lenders control if certain negative triggers occur. Understanding what these clauses mean, how they’re applied, and how to negotiate them can help founders stay in control – and out of the “penalty box.”
What Is an Event of Default?
An event of default is a contractual condition that allows a lender to demand immediate repayment or take control if the borrower fails to meet agreed-upon terms. In venture lending, entering default gives the lender leverage – they can force fundraising, demand repayment, or even require the sale of assets or the company itself.
While many defaults result from clear issues like missed payments, others – like investor abandonment or “material adverse change” provisions – can be more subjective and dangerous if not negotiated properly.
Common Events of Default in Venture Lending
1. Non-Payment
The most obvious event of default is failure to make loan or interest payments when due. Even one missed payment can trigger default unless a short grace period is built into the agreement.
2. Insolvency or Bankruptcy
If a company becomes insolvent or files for bankruptcy protection, the lender immediately has the right to demand repayment or seize pledged collateral. This one is non-negotiable – it’s automatically applied to nearly all venture debt agreements.
3. Breach of Covenants
Lenders set affirmative (things you must do) and negative covenants (things you must not do) as part of the loan’s conditions, like maintaining a minimum cash balance, not taking on new debt, or ensuring timely financial reporting. Violating any of these financial or operational covenants can trigger default – even unintentionally.
4. Investor Abandonment
In venture-backed companies, lenders view continued investor support as a risk signal. If existing investors decline to participate in follow-up rounds or withdraw financial backing, that can be labeled an “event of default.” Founders should watch for this clause and negotiate its removal or clarification to prevent lender overreach.
5. Material Adverse Change (MAC)
Perhaps the most subjective default trigger, a MAC clause gives the lender power to declare default if they believe the company’s financial condition has materially worsened. The phrase is intentionally broad: market contractions, missed targets, or unfavorable investor news could all qualify. Startup-friendly lenders rarely activate this clause, but founders should negotiate narrower language limiting a MAC to major, clearly measurable business downturns.
6. Litigation or Material Contract Breach
Significant lawsuits or breaches of important business contracts may also trigger a default if they threaten the company’s ability to repay debt. Ideally, founders should push to include a dollar threshold – for example, only lawsuits exceeding $150,000–$200,000 count as defaults.
7. Change of Control
If your startup is acquired, merges with another company, or sells a significant portion of its assets without lender approval, it can count as a “change of control” default. Lenders include this clause to maintain oversight of major ownership changes that could alter credit risk.
The Real-World Impact of a Default
When an event of default occurs, lenders can take several actions:
- Accelerate repayment – demand immediate payment of the full loan balance.
- Limit or freeze access to additional funds under the lending facility.
- Seize or liquidate collateral pledged under the loan terms.
- Renegotiate loan terms under more restrictive covenants or higher pricing.
In practice, lenders often prefer to restructure rather than immediately foreclose. However, once a default is triggered, startup leverage evaporates – the lender effectively controls the company’s financial destiny.
How Founders Can Stay Out of Default
- Negotiate default clauses early. Make sure events of default are clearly listed in the term sheet, not just hidden in final loan documents.
- Watch subjective triggers. Push for specific terms in clauses like “material adverse change” or “investor abandonment.”
- Set monetary thresholds. Small contract disputes or minor liabilities shouldn’t trigger default events.
- Maintain open lender communication. Regular updates, financial reporting, and transparency can prevent escalation if a covenant breach is looming.
- Work with your legal and accounting team before signing. Experienced advisors can spot hidden risk language before all the documents are finalized.
Avoid Penalties
A venture loan should accelerate your startup’s growth – not create hidden traps. By understanding and negotiating event of default clauses early, founders can keep control and preserve flexibility through future growth and fundraising. Kruze Consulting helps venture-backed startups navigate the complexities of venture lending – from term sheet review to debt compliance and financial management – so you can raise capital and avoid costly surprises down the road.
Learn more about Venture Debt and how Kruze Consulting can help you in the process.
