Is it reasonable to agree to a CEO removal as an event of default when bringing on venture debt?

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Kruze Consulting Startup Q&A Author
Vanessa Kruze
Founder, CPA

Before joining the Startup CFO firm, Kruze Consulting, I was a partner at Lighthouse Capital, one of the leading venture lending funds. I did about 100m+ of debt deals while at Lighthouse and I do a ton of Venture Debt consulting at Kruze Consulting nowadays.

When a Lender funds a startup, one of the biggest variables they are underwriting is the Management Team. They are betting on the team in the same way an investor does. If the company struggles, the Lender must depend on the CEO & Management to raise more equity or find an acquisition offer for the company. Otherwise the company and the loan are doomed.

Given how much the Lender depends on the CEO, it’s understandable that the Lender would want the CEO to be in place. I believe a Funding Contingency based on the CEO still being in place is fair for both sides. That means the Lender doesn’t have to fund if the CEO is fired. VC’s understand this request and I’ve never had one push back except in the situation where the Board and existing CEO were already looking for a new permanent CEO.

An Event of Default is much more serious than a Funding Contingency because the Lender has remedies that could be dramatic, especially in the case of a Bank Lender that holds the company’s cash. In that case, firing the CEO could trigger a default that could see the company’s cash swept. Therefore I encourage all my venture debt consulting clients to push back on this term. It’s a bad idea to put the company in this kind of jeopardy.

A Funding Contingency tied to the CEO is reasonable, but an Event of Default is not.

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