Venture Debt: A Guide for Startup Founders

Venture debt is an increasingly popular financing tool for venture-backed startups aiming to accelerate growth, extend runway, and minimize equity dilution. As an accounting firm specializing in venture-funded startups, we frequently receive questions from founders about how they can leverage venture debt strategically, in conjunction with equity fundraises. This guide explains what venture debt is, how it works, and how it can help you avoid dilution, so you can make informed decisions for your company’s future.

What Is Venture Debt?

Venture debt is a typeof debt financing designed specifically for early and growth-stage startups that have already raised venture capital. Unlike traditional bank loans, venture debt does not require significant collateral or a long operating history. Instead, lenders focus on your company’s growth potential and backing from reputable venture investors.

Venture debt typically comes in the form of a term loan or line of credit, provided by specialized lenders, venture banks, or funds that understand the unique needs of high-growth startups.

Key Features:

• Timing. Most startups secure venture debt shortly after a successful equity round (Seed, Series A, or later).
• Loan size. Typically, 20-35% of the most recent equity round (e.g., if you raise $10M in equity, you might access $2M to $3.5M in debt).
• Repayment. Standard terms are 24-48 months, often with an initial interest-only period followed by principal repayments.
• Interest Rates. Generally higher than traditional bank loans (often 8-12%), reflecting the higher risk profile.
• Warrants. Lenders usually receive warrants – rights to purchase a small amount of equity at a set price. This results in minimal dilution, usually less than 1% of your cap table. Note: While dilution is minimal, warrants still impact your cap table, especially if your company’s valuation grows significantly.
• Covenants. May include financial or operational covenants, such as minimum revenue targets or reporting requirements. Note: Breaching loan covenants may trigger penalties or even default, so make sure you understand all terms before signing.

Kruze Consulting has a free sample venture debt term sheet with a detailed analysis of the different clauses that you can review.

Why Use Venture Debt?

So why would founders consider venture debt instead of more equity? After all, venture debt has to be repaid. The reasons startups turn to venture debt financing include:

• Preserve ownership and minimize dilution. The primary appeal of venture debt is its ability to provide additional capital without significant equity dilution. Unlike raising another equity round – which requires giving up ownership and possibly board control – venture debt allows you to access funds while keeping your cap table intact.
• Extra funds to extend runway and reach key milestones. Venture debt is often used to extend your financial runway by 6-12 months, giving you more time to hit critical milestones (such as product launches, revenue targets, or market expansion) before raising your next equity round. This strategic timing can lead to a higher company valuation and less dilution when you do raise equity.
• Bridging between equity rounds. If market conditions are unfavorable or you need more time to achieve traction or reach milestones, venture debt acts as a bridge, helping you avoid a “down round” or unfavorable terms.
• Faster and more flexible than equity. Raising venture debt is often faster than equity fundraising, with deals closing in as little as 30 to 60 days. The process involves less due diligence and negotiation. If you’ve got time-sensitive growth opportunities, raising venture debt could get you the necessary funding more quickly.
• Retain control. Unlike equity investors, venture debt lenders typically do not demand board seats or operational control, allowing founders to remain in charge of strategic decisions.

How Does Venture Debt Minimize Dilution?

Dilution is usually a top concern for startup founders, which makes venture debt an attractive funding option. Issuing new shares for an equity round reduces a founder’s ownership percentage, which can affect their control over the startup’s direction. Here’s a summary of the dilution differences between equity rounds and venture debt:

• Warrants. While venture debt lenders may receive warrants, the resulting dilution is usually a fraction of what an equity round would entail.
• Strategic timing. By using debt to reach higher valuations, you can raise your next equity round on better terms, further reducing long-term dilution.

The Venture Debt Process

To apply for venture debt, startups typically prepare a comprehensive application package – including a pitch deck, financial statements, and growth projections – and contact lenders to present their business plan, financial health, and ability to repay the loan. The process typically takes 8-12 weeks from initial outreach to funding, so starting early is advisable. Once approved and funded, the company uses the capital for specific growth initiatives while carefully managing loan terms and repayment schedules. You’ll also need to communicate regularly with the lender throughout the life of the debt. The specific steps include:

1. Demonstrate eligibility. Your startup has raised venture capital and is showing strong growth potential.
2. Complete applications. You contact a venture debt provider, who evaluates your business plan, recent funding, and growth trajectory. Typically, startups approach two to five different lenders to compare terms and maximize negotiating leverage.
3. Negotiation. You’ll need to evaluate your loan offers. Venture lenders will provide a term sheet, which is a non-binding document that outlines the terms and conditions of the loan. Key terms – loan amount, interest rate, repayment schedule, covenants, and warrant coverage – are discussed and agreed upon. Important tip: Every startup should work with an experienced attorney to review and negotiate any loan terms and conditions.
4. Finalize the loan. Once you’ve agreed on terms, the lender will provide detailed legal documentation to finalize the loan.
5. Funding. Upon agreement, you receive a lump sum or access to a credit line, which you can use for growth initiatives.
6. Repayment. You make regular interest (and eventually principal) payments. When the loan matures or is repaid, the lender may exercise their warrants, resulting in minor equity dilution.

When Should Startups Consider Venture Debt?

Venture debt should be raised proactively – in other words, don’t wait until your cash is low before you apply for a venture loan. It’s easier to get a loan when you’ve got 12-18 months of runway and you’re in a position of financial strength. Even though you don’t need the cash now, a venture loan can serve as a financial buffer in case you run into issues or delays. Venture debt is best suited for startups that:

• Have recently raised a successful equity round.
• Are generating revenue or have solid prospects for future funding.
• May require additional capital to achieve specific milestones or bridge the gap to profitability.
• Want to avoid unnecessary dilution before a major value inflection point.
• Have a clear plan for repayment, either through future fundraising or growing cash flows.

Venture debt isn’t recommended for:

• Companies with weak margins, high burn rates, or uncertain paths to profitability.
• Startups unable to raise equity at all – venture debt is a supplement, not a substitute, for equity.

Venture Debt is a Powerful Tool for Startups

Used strategically and with careful planning, venture debt can help you optimize your capital structure and maximize your company’s long-term value – while minimizing dilution and retaining control. If you’re considering venture debt or want to understand how it fits into your financing strategy, our team of experts is here to help. Contact us to discuss your options and chart the best path forward for your venture-funded startup.