Video: Why do Venture Debt Lenders Want Warrant Coverage?
The rationale for a warrant coverage or a little bit of equity upside for the lender is that they’re taking a lot of risks here. They’re lending money to startups, which are risky.
The lender wants to participate in the upside of the startup, therefore the lender will often ask for anywhere from 2% to 10% of the loan amount to be in the form of equity. That means if it’s a million dollar loan, the lender may be looking for $20,000 up to $100,000 of extra equity.
It’s kind of like a stock option. If the company does really well, the lender can exercise the warrant and participate in the upside. That’s how warrant coverage for loans works in the venture debt space.