Venture Debt

Startups raise venture debt to extend their runway and by enough time to hit milestones, it must unlock to raise its additional capital. Runway extension is the most important reason for Venture Debt.

Another reason to raise venture debt is to refinance existing debt. When a startup completes an equity round, it’s time to shop the deal and refinance with either existing lenders or bring a new lender into the company. Refinancing debt also extends a startup’s runway.

A third reason is to fund an opportunistic new project that isn’t in the startups budget currently but will add tremendous value. A little extra cash from the debt can fund an optional but value-add project.

The fourth reason is to create optionality if the company is in acquisition talks with an acquirer. Venture debt doesn’t require resetting the company’s valuation in the way a new equity round would reset the valuation. Once the valuation is reset higher, the acquisition price must be higher and the new investor must agree to the deal.

First, you’re going to need a bank to deposit that big VC check. :)

It’s best to work with a bank that focuses on startups. Kruze has a list of the best banks that serve startups, and we know the technology teams at these banks. We’re happy to make introductions, just let us know.

Second, it’s a good time to start expanding your recruiting work. Entrepreneurs often underestimate the ramp time to actually hiring new team members, and if you fall behind in recruiting, you’ll fall behind on your operating plan and milestones. We recommend “Recruit” to jump-start your recruiting efforts. Don’t delay your recruiting, you’ll fall behind.

Next, you need an accounting firm! Kruze is the best and we’ll handle your taxes, your monthly accounting, give you a Fixed Fee for your Monthly Close. Having accurate financials allows you to pinpoint where you’re spending your money and report back to your VC’s. VC’s need real reporting and also want the company to be in Compliance (Taxes, State Registrations, etc). Hiring an accounting firm like Kruze will solve this problem and give you peace of mind too.

Fourth, it’s never too early to plan for your first board meeting. That first meeting is the foundation of the relationship of the relationship with your VC’s. If you’re prepared, have accurate financials and lay out your milestones, your VC’s will breathe a sigh of relief. Discuss your key initiatives, where you’ll be spending the VC’s money and drive a consensus. If the first Board Meeting is done right, it will instill a lot of confidence in your VC’s.

Finally, you want to start evaluating Venture Debt. Lenders love to come into a company that has raised a fresh round of equity. That way there is no adverse selection for them. Everyone is happy and it’s easier for the lender to make a commitment. The old saying, “You need money to borrow money,” is true. Lenders will give your startup a forward commitment so you can draw the money in the future when you need it and that way you don’t have to draw the money right away and needlessly pay interest. Get the debt in place right after the round and you’ll be happy you have that runway extension later. So, to reiterate, establish a startup bank (First Republic), accelerate your recruiting efforts, hire an Accounting firm like Kruze Consulting, prep for your first board meeting and put a venture debt line in place!

There are two types of venture debt deals.

There’s a bank term sheet and then there’s the fund term sheet. The banks, again, are usually a little bit more restrictive and use investor abandonment clauses so they can be more aggressive on the interest rate; aggressive being lower. A typical bank interest rate will be somewhere around five, five and a half, six percent all in. That’s the cash interest you’re paying every year on the money you borrow.

Now, funds, they actually let you use the money a little bit more fluidly and so they don’t have the MAC or investor abandonment. Therefore, they need to charge more. Thus, the average interest rates we’re seeing on fund term sheets are somewhere around ten and a half to twelve percent. That’s the TriplePoint, WTI, type of deals. All in ten and a half to twelve percent interest rates.

Sometimes the upfront interest rate is a little bit low like maybe 8 percent. And then there’s a final payment that is paid at the end of the loan which brings the total IRR up to that ten and a half percent range.

A typical venture debt deal can be kind of two flavors.

First is the bank, and again banks use investor abandonment, some of the stricter clauses, so they can be more aggressive on warrant coverage. And by aggressive, I mean ask for less work and less ownership in your startup. A typical bank warrant coverage will be somewhere around 1 percent of the deal amount so, to a million-dollar loan, 1 percent of that would be ten thousand dollars in a warrant, something around there.

Now, usually, you can also translate this to fully diluted ownership in the startup and that’s usually going to be around .1 percent. So, point .15 percent of the startup. So, again, banks are cheaper because they use more restrictive clauses. Nothing wrong with that. They’re upfront about it. Just know that’s going in.

The second type of lender is a fund lender. Now they’re letting you use the money a little bit more flexible and in a more flexible manner. And so, they’re going to charge more. They don’t have the MAC. They don’t have the investor abandonment. Typical warrant coverage for fund lender is anywhere from 6 to 10 percent of the deal.

So, again, in that million-dollar deal scenario, we’re talking from 60,000 dollars to 100,000 dollars of warrant coverage or equity in your company. Now, that usually translates to about 25 to 50 basis points of the entire company. Sometimes, when the fund lender is being very aggressive and giving you a lot of money, that number can actually edge up to 1 percent of the company total value or total ownership.

Now again, the great thing about venture debt is it’s less dilutive. So, you’re getting a lot more cash and you’re giving up less ownership. However, you always need to remember that this money needs to be paid back. Investor equity dollars don’t necessarily need to be paid back. Or in a downside scenario aren’t going to be paid back. So, the lender is trading off a lot of risk for a lower return.

And so, again, we see on average warrant coverage for a bank is going to be somewhere around 1 percent. And for a fund lender that’s going to be six to 10 percent of the deal amount and for the bank that’s going to translate to about .1 percent of the company.

And for the fund lender, it’s going to be a point to .25 percent to .5 percent. Those are averages but that’s typically what we see at Kruze Consulting when we’re negotiating venture debt deals.

The big reason why startups use letters of credit is to give their landlord at their new office space a defacto deposit. It’s basically collateral for the landlord. And so, what the startup will do will have their bank issue a letter of credit may be for $100,000 maybe for $200,000. The bank will segregate that cash out of the startup’s normal operating account, back the letter of credit with that cash, the startup can’t touch it anymore because it’s backing that letter of credit, and then the bank hands over the letter of credit to the landlord.

Now, this is preferred because you’re not… You don’t necessarily want to transfer a hundred, two hundred thousand dollars to your landlord. and just hope they’ll get it back for you. Having the bank on your side, having it documented in a letter of credit is much safer for the startup, and it’s much easier logistically.

So that’s why startups use a letter of credits. There’re a few other reasons like inventory deposits or things like that, but it’s almost always used to secure new office space.

Debt can be highly effective for a startup to extend its runway and then hit a big milestone that makes fundraising easy and leads to an up round. However, if a startup over-leverages itself and raises too much debt, the company can become impaired and future fundraising gets really difficult. Don’t raise too much debt and put your startup at risk! We recommend raising no more than six months of extra runway. The biggest reason debt can hurt your startup is that the next investors will not want to see their new capital go to pay back the lender. They’re investing to help grow the company, not to de-risk and pay back the previous lender. Too much debt can create an overhang for new investors. Our simple guidance is to raise three to six months of runway. Startups often unknowingly sign up for dangerous terms like MAC (Material Adverse Change) or Investor Abandonment Clause which can create a default at the worst times. Those terms give the lender a lot of leverage over the startup if things go wrong. To summarize, don’t over-leverage your startup and raise more than 6 months of runway in debt, and beware MAC’s and investor abandonment clauses.

Many people don’t realize it, but startup venture debt got its start from equipment leasing and financing programs. Startups that needed expensive equipment like manufacturing machinery, computer hardware, and laboratory equipment looked for financing and leasing options to avoid purchasing equipment outright. That allowed those startups to begin operating without large upfront capital expenditures, effectively providing them with capital. Over time financial institutions realized that extending loans to startups could be a profitable line of business.

Successful startups typically raise future venture capital rounds at higher and higher valuations, meaning future capital is less dilutive, or “cheaper” than current capital. Therefore, venture debt providers will often ask for a payment at maturity that boosts the overall IRR of the loan but will be 3 or 4 years out into the future. This effectively backloads interest when it is less expensive for the startup. The lender hits its return hurdle and the startup back loads interest when the capital to pay it back comes from a less dilutive source.

Fintech companies have special capital structure considerations, especially when it comes to mixing debt and equity to drive growth. Fintech startups should start by raising equity capital to prove out their business model. As they are working on getting the business model doing, by burning that equity cash, they will want to find a debt partner who will help them in the next stages of their growth. At the Series A, they should consider raising a combination of equity and non-equity capital to fund the business. Listen to our video to learn more.

Banks are able to lend to startups cheaply because their source of funds (customer deposits) are inexpensive because interest rates on checking and savings accounts are almost zero. However, Banks are Federally regulated and must be careful not to lose customer deposits on bad loans. Therefore, they rely on Material Adverse Change Clauses (MAC), Investor Abandonment Clauses and Other Covenants to control their risk and limit their losses.

Most banks have moved away from MAC clauses, but almost all bank term sheets include investor abandonment clauses. This term means a bank can force your investors to put more money in the company and if investors don’t act, then it becomes an event of default. Once a company is in default, the bank can sweep the cash to make themselves whole. Banks do this rarely and don’t like doing this, but it is the way they manage risk and losses.

In summary, banks leverage their low cost of capital from customer deposits, and the ability to use an investor abandonment clause, to lend cheaply. However, remember banks are not very flexible and need those covenants in the deal.

Comparing the Banks vs. Fund Venture Lenders, like a BDC or actually a pure venture capital fund, you’ll see Fund lenders are much more flexible but more expensive. Fund Lenders cost of capital is much higher because they are getting money from big institutions like endowments, foundations, and/or public investors (BDC) so they have to deliver a high return for those investors.

Fund Lenders justify the higher cost is by providing a high degree of flexibility. No material adverse change clauses, no investor abandonment clauses, providing larger deal amounts than banks would provide a startup, and longer interest-only periods.

So, Kruze Consulting views Funds and BDCs as flexible, very aggressive, but expensive. Banks are very conservative, like to tie you up a little bit, but are very cheap.

Startup Founders have to decide what type of lender and what type of risk profile they can live with. Founders spend many years of their life building their companies. Lenders can alter the mix between the VC Investors and Founders, At Kruze Consulting, we have many clients that borrow from banks because of the Founders and Board like the cheap cost of capital. At the same time, many startup clients will borrow from fund lenders because they’re willing to pay for that extra flexibility, extra dollar amounts, and extra interest-only periods.

Kruze has done the work for you by compiling summary scouting reports on the premier startup banks: Square 1 Bank, Comerica, City National Bank, and Bridge Bank.

Kruze has also developed scouting reports on these funds: Western Technology Investments (WTI) and TriplePoint.

This venture debt term allows the lender to refuse new loan drawdowns if there has been a Material Adverse Change in the business. This clause gives the lender wide latitude to refuse a drawdown. It’s less dangerous than a MAC Default that can put the startup into foreclosure, but it can be used to deny the startup funding. It’s an important term if the startup is planning on drawing the capital far into the future. It’s less problematic if the startup will draw the capital immediately, since you’ll already have the funding from the loan in the bank and won’t have to take future drawdowns.

The first step in Kruze Consulting’s Venture Debt process is to sit down with the CEO and determine if the debt is a good fit for the company. When the business is on the downturn, debt is not a good idea because adding a senior secured creditor to the mix only makes life more difficult over the long term. The next fundraise can be messy if a majority of the proceeds will go to paying back the debt. However, if the business is booming and you’ve recently completed a round, venture debt with a forward commitment to draw down is a great tool to put in place.

Especially after raising a new VC equity round, the company is in great shape and there is little risk of asymmetric information for the lender. That’s when a debt vehicle should be put into place.

After determining whether the debt is a good fit, Kruze will make introductions to its preferred lenders. Our team knows all the lenders so it’s easy to kick the process off quickly.

There is a temptation to talk to tons of lenders but we recommend a bank and two fund lenders to start. Once you get traction, you can do a couple more meetings to help optimize terms. More than three lenders can be a distraction. After introductions, Kruze will assemble a powerpoint pitch deck, historical financial statements, future projections, a cap table, and 409A valuations. These are the core pieces of information that lenders want to review.

After the lender reviews the materials, the deal sponsor will engage their credit committees and decide on a term sheet. As soon as the term sheet reaches the startup, Kruze will analyze the offer, explain all the difficult debt terms, explain to the CEO and Board of Directors what the term sheet means for the startup, model out the incremental runway from the debt and overlay the runway with the key milestones for the next fundraise. Kruze will model out the IRR, or cash cost, of the debt so Management knows how expensive the debt actually is for the startup. We’ll also model out and explain the warrant coverage, or equity upside, so Management and the Board know how much of the company it is giving away. Venture Debt is all about extending runway so a startup & CEO should be sure they’re buying enough insurance to achieve their milestones and raise an up valuation round.

Kruze will also walk Management through downside scenarios – if the startup is not achieving its milestones, how badly will the debt hurt the company?

After negotiating the debt deal and reaching a signed term sheet, Kruze will assist in the documentation process although this is mostly the domain of company counsel. Usually, a term or two become critical during negotiation and Kruze can assist the lawyers to explain the pros and cons of Management. Startups usually engage a venture debt specialist at their favorite law firm and those lawyers do a great job. It’s best to use experienced venture debt lawyers who can advise how key terms can affect the company’s business. Once the deal is documented, Kruze will advise on when the capital should be drawn down from the lender. That’s the venture debt process from start to finish and how Kruze Consulting can help!

Asking for an extension on a venture debt line is a pretty common request from startups. They do this because they want to be able to preserve the ability to draw the loan, but don’t need it quite yet. So they’re going to ask the lender to extend that drawdown period.

If it’s a short drawdown, the lenders are usually pretty happy to comply. After all, they want you to draw the money down. That’s how they make money on interest.

However, it’s going to be a lot easier if it’s a short term extension, like one or two months, because anything longer than that, they’re starting to extend the risk.

Tips for maximizing the chances of getting an extension: Have this conversation at least two months before the extension, before the original line runs out. Don’t do it last minute, in the last couple of weeks before your drawdown period ends. Provide an update on the company how business is going, your cash balance, cash burn. Send all your financials. Refresh and share the cap table. Have a really proactive conversation with a lender.

The lender is going to have to take it to their credit committee and get it approved. But usually a one or two-month thing, they’ll oblige. Now, if you’re looking for something like three to six months, or three to nine months, that’s a whole different ball game. That’s basically treating this deal as a new deal. And oftentimes the lenders will still want to comply because they still want your business, but they’re going to underwrite it in the same way they underwrote your first deal. So they’re going to do some real in-depth due diligence. They’re really going to do a big presentation, their credit committee, and they’re going to probably ask for some compensation in the form of maybe a loan extension fee or some more worth in the company. After all, they’re taking more risk, thus more risk than they originally thought they’re going to take and it’s going to be super important that your company is still executing.

Typically, when the company asks for an extension, it means actually the company is doing well because they don’t really need the money. So that makes the lender want to participate. But if your company is struggling, and you’re asking for two to six months, be prepared for the lender to say no.

If the lender says no on a larger extension, then you can go get another deal put in place or go to your investors and ask for more money.

One of the most ambiguous and dangerous terms in a venture debt agreement. the Investor Abandonment Clause can result in the startup being declared in default of the loan. This term is typically used by a bank to create an event of default if the company is not performing. The venture debt lender can call or email the startup’s investors and ask them to put more money into the company. If the investors decline or don’t follow through with an additional investment to the bank’s satisfaction, the bank can put the company into default and pursue remedies including foreclosure. Banks often say they rarely invoke the Investor Support clause, which is true. However, the bank requires this term so that they can use it or at the very least create leverage. This clause can also create a lot of investor leverage to the Founders detriment because the only way to escape foreclosure is to have insiders write another check.

Material Adverse Change clauses are another ambiguous term that lenders use to create an Event of Default. Once a startup is in default, the venture debt lender has tremendous leverage and can pursue remedies like foreclosure. When a lender invokes a MAC, the lender is claiming that something has changed and the borrower will likely not be able to repay the loan. This is an interpretative clause and not a good clause for a startup to agree to. Sometimes Lenders will limit the conditions a MAC can be invoked but we recommend never agreeing to a MAC.

Banks typically require a minimum cash requirement to reduce their risk. The bank’s goal with this term is to ensure there is adequate cash in the bank account to cover a big portion of the loan if things go poorly. Banks are federally regulated because they loan out other companies’ deposits so they can’t take a lot of risks. The minimum cash requirement limits their risk. This is not a good term for the startup because you’re effectively borrowing your own money and can’t use the capital to extend runway as long as you would like.

An example of a minimum cash requirement is a bank that could provide a $2 million loan, but it requires $1 million to stay in the bank at all times. Therefore the startup only really gets to spend $1 million of the loan extending its runway.

Kruze Consulting aggressively negotiates these out of term sheets whenever possible. If you can’t get it out of your term sheet, then push to reduce the minimum cash requirement as much as possible. Reducing the minimum cash requirement means you are maximizing your runway so you can hit your milestones and raise a big equity round in the future.

Normally venture debt lenders charge a small pre-payment fee of 1 - 3% of the remaining principal outstanding. If there is a “Final Payment” component of the loan, then that will be due at the time of prepayment as well. Note lenders don’t like pre-payments because only their best companies can afford to pre-pay. Therefore the best credits are refinancing out leaving the lender with less attractive borowers.

The supreme lien basically says, ‘Hey, we’re not going to take a lien on intellectual property of the company but if you do get in trouble or hit a go below a cash balance that’s predetermined by the lender, then the lien springs into place and the lender can perfect and actually be confident that they will control that asset.’

Thus, a very common scenario would be maybe a company borrows 5 million dollars of venture debt and the lender says, ‘Hey, as soon as you go under 5 million dollars in cash after you’ve withdrawn our money then we want the lien-in IP to spring into place.’

Before that, ‘Hey, we’re good we don’t need the lien. We trust you.’ But at that moment, that is when the lien is triggered or springs into place. And so, the advantage of this; it’s not a huge advantage to the startup because again when things kind of get bad, the lenders still going to have lien-in IP but it can give the board some comfort and the management team some comfort that the lender won’t always have the lien-in IP and will be a little bit friendlier to deal with until the company hits that predetermined cash balance. Or maybe it’s a revenue covenant something like that.

The lien only comes into play or springs into place when the company triggers some type of covenant that has been predetermined by both the company and lender.

This is the legal term but actually, it can have a really huge benefit for a startup.

A cooling off period basically refers to the lender not aggressively foreclosing on the company if they’re in default and where this really comes into play it is if the company has given the lender a lien on the intellectual property and all the other assets.

When that lender has a lien on all assets including actual property they can foreclose very quickly in 10 to 15 days because they don’t have to notify the other creditors who benefit from the sale. If the lender doesn’t have all the assets like a lien on IP they’ll have to notify all the other creditors like the water person or Kruze Consulting or whoever else the company owes money to. That usually takes 60 and 90 days for foreclosure. So, the cooling off period becomes very important.

If the lender has all the assets Lien on IP with the cooling off period says is something to the effect that the lender will not foreclose and sell the company within something like 90 days or 120 days that’s very negotiable as long as the management team is involved and the board is involved and they’re helping to sell the company. What the lender really cares about is if the company actually gets sold and the lender knows that if it’s sold without management team cooperation and board cooperation then they’re going to get ten cents on the dollar. They are going to have a very good recovery. So, what the lender is doing in agreeing to a cooling off here is saying hey as long as you’re playing ball and helping us sell the company helping us get our money back we’re fine not aggressively foreclosing for 90 or 120 days. So, this is a very important term. If you’re giving your lien on IP away to the lender because what you’re basically doing is ensuring as long as you’re engaged as the management team and board you’re not going to get taken advantage of and have a really quick foreclosure.

Now, of course, say you agree in this term in management and just quits and will not help the lender sell the company. Then, of course, the lender is going to move quickly and this term will be thrown out the window.

But I do recommend putting this cooling off period language in a term sheet that you’re giving all the assets of the company with.

All due diligence starts with historical financials. The lender wants to make sure the company has spent its money wisely and can establish a burn rate trend.

Second, lenders want to see future projections. Projections or a Financial Model allow the lender to pinpoint the startup’s cash out date, recognize revenue inflection points, and model out how long the cash infusion will last the company.

Lenders also want to see the cap table so they can see the round prices, especially if the lender is pricing the warrant based on a recent common stock valuation. Understanding the ownership breakdown and which VC’s own how much is important as well. Lenders also like to see the 409A valuation.

Lenders will need an investor presentation as well so they understand the company’s technology, go to market strategy and key performance indicators (KPI’s).

The credit committee will evaluate all these data points, underwrite the deal, and give the startup a term sheet!

An event of default is when a startup violates a covenant or does not pay their monthly loan payment. Once a startup is put into Default, the lender controls the companies destiny and can make themselves whole by taking remedies like sweeping cash. A startup should do everything possible to start out of Default. Once in Default, Lenders can make a company fundraise, sell the company or even shutdown. Staying out of default is rule number one.

Rule number two is that a Startup should always insist the Events of Default be in the term sheet. Some lenders get a little sneaky and don’t include the Events of Default in the term sheet. Make the Lenders define the Event of Default before you sign the term sheet so you have the most leverage to negotiate favorable Events of Default. The most common Events of Default are Insolvency or Non-Payment. If you don’t pay your loan, you’re going to be in default. Insolvency is when you don’t have enough money to pay your bills. The Events of Default Startups should be very careful of are Investor Abandonment or Material Adverse Change (MAC). Lenders can use those terms to create a default situation so Startups have to be careful. Regarding an Investor Abandonment Default, the Lender will demand your investors put more money in the company and if the Investors refuse, a default is triggered. Kruze recommends staying away from MAC’s because if there is a big shift in the investment climate or economy, a Lender may try to use a MAC to create a Default. Always try to negotiate a MAC out of your deal. Another lesser-known event of default is when a startup has a material contract breach or it is sued. The Loan Documentation will assign a $ amount threshold where a lawsuit or contract breach becomes a Default. Startups should push for that $ amount threshold to be as high as possible.

If a startup is Series A or B, then that threshold should be a $150,000 to $200,000. The higher threshold means that a small lawsuit of $20,000, will not trigger an event of default.

Venture Debt Lenders ask for equity in the form of warrants to give the lender upside potential on successful companies. This equity component is in addition to the interest rate and final payment. It’s normally quoted as a % of total commitment. As an example, 10% warrant coverage of a $3M loan would be $300k in Warrants. The number of shares in a warrant is derived by the dividing the latest preferred share price into the total $ amount of the warrant. Sometimes lenders will take Common Stock Warrants instead of Preferred Warrants. Do not expect to raise venture debt with out the lender getting warrants, but know that the warrants are going to be much less dilutive than if your startup had raised the same dollar amount of venture capital.

When a lender agrees to a deal, they are committing a million of dollars to the startup. Therefore, they want to get paid both in cash interest and some equity upside via warrants. The lender wants as much equity based committed upfront as possible.

However, the startup wants to preserve as much option value as possible and will ask for the warrant coverage to be based on usage, or the amount drawn down. Often a startup borrower only draws down a portion of the loan so paying all the warrant coverage upfront on committment seems like a waste.

Deals typically end up in the middle with half of the total warrant coming upfront based on commitment and a half on usage. A simple example with easy math is as follows: Warrant Coverage on a venture debt deal is 6% of the total deal amount. About 3% of that would be based on commitment, and 3% on usage. Negotiating warrant coverage to be based on usage can save the startup a lot of unnecessary equity dilution and make venture debt even more attractive.

In venture debt, you have two types of lenders: banks, and then the fund lenders. So let’s go through the banks first. Banks tend to be a lot cheaper. So right now it’s somewhere between 5 to 7% interest rates.

And then the warrant coverage is also a lot cheaper. Usually, it’s like 1% of the deal amount. Maybe 2% of the deal amount. Usually that kind of equals like .25% of the company’s total ownership.

So banks are much cheaper than fund lenders. Those are the prevailing rates but also remember, banks typically use Investor Abandonment clauses, MAC clauses, other covenants that kinda restrict you a little bit, that’s how they can get away with having lower interest rates and lower warrant coverage.

Now fund lenders, they’re more flexible. They really let you use the money and typically do bigger deals, but they’re more expensive, so fund lenders what I’m seeing these days, is anywhere from 11 to 13% interest rates, that’s on the cash side.

Then the warrant coverage is anywhere from 8 to 12% of the deal amount. So if you’re doing a million-dollar deal, and the warrant coverage is 12%, which is on the high side. But I’m seeing that quite a bit, then that will be a hundred and twenty thousand dollars of warrants in the company, above and beyond what the interest rate cash payments are.

So hope that helps. Again, banks somewhere around 5 to 7% interest rates, 1 to 2% warrant coverage. Funds, anywhere from like 11 to 13% interest rates, and warrant coverage from 8 to 12% of the deal amount.

When you take venture debt from a bank, they may ask for a right of offset. Non-bank venture lenders can not ask for this - only a bank that has your checking/savings/money accounts can do it.

• If a bank has an asset (your cash) and a liability (loan out to you) they can offset them against each other
• Dangerous for startups
• Banks only invoke the right of offset if company is in default
• Talk to bank about this before taking a bank loan

The definition of venture debt (also referred to as venture lending) is a category of debt financing options for early-stage and fast-growing private companies. These securities are created specifically for startups that do not have strong/positive cash flow, and typically are two to four year loans, revenue-based loans or equipment leases.

If you’re trying to raise venture debt, and you can’t do it, that probably means you’re getting a little tight on capital, and so there are some other things you can do to stretch out your company’s runway. The first thing is, there are other lending options, there are revenue-based lenders like Lighter Capital. And they will look at your revenue, give you an advance and then take a portion of that revenue every month, like kind of like four to eight percent of the revenue.

Now it’s expensive money, the IRRs are in the high teens, but it’s a really good option if you’re having trouble raising venture debt. Another thing you can do is go back to your equity investors and see if they’ll do a bridge round.

Now VCs don’t really like to do bridge rounds, but they will do it to support good companies. And really, that’s one of the ways VCs really build their reputations. So it’s worth having the conversation.

Another thing you can do is go to your customers and create a win-win. And you can offer them a discount, you might even want to change your incentive plan for your salespeople a little bit too. Because if you incentivize your salespeople to collect more cash upfront and a lot of times they’ll give the customer a discount to pay upfront, you can actually collect a lot of money.

Often times, companies will sign multi-year deals, and pay the whole thing in advance if the discount is big enough, so that’s a really good one. And finally, if those options aren’t working for you, you may need to cut some burn rate. So, build your financial model. Look at it and look at where your cash goes. And where you’re supposed to hit those milestones.

And if you don’t have enough runway, then that’s the moment where you should make some adjustments. You’re probably gonna have to let some really great people go or maybe not spend money on some really critical vendors. But that’s the trade-off you need to make to extend your runway. So again, you’re going to look at revenue base debt. You’re gonna go back to your VCs for potentially a bridge loan, create some win-wins with your customers to incentivize them to bring cash into the company faster, and you may have to actually cut some burn rate.

For startups, Venture Debt functions a lot like Insurance. By taking on incremental capital in the form of Debt, your startup buys itself another three to six months of the runway.

Lenders like to put a debt deal in place when the company raises a new round of equity. So the typical series A or series B startups raise 15-20 months of cash via equity. With debt providing an extra three to six months of runway, the startup has additional room to achieve its milestone and raise its next round at an up valuation.

We’ve seen all the mistakes in the book when it comes to bringing leverage onto early-stage companies. But here are the top mistakes we see founders make over and over - watch out for number three in particular!

1. Raising too much money - “Give me as much as possible”
2. vInstead, ask for 25-40% of equity raise or 3-6 months of runway
3. Not diligencing the reputation of the lender
4. Optimizing for cost instead of flexibility
5. Negotiating too short of a term & interest-only period
6. Treating Venture debt as a bridge loan
7. Bad communication with the lender after the deal

• Venture Debt is debt capital for startups to extend their runway
• Drawdown the capital in the future and make a forward commitment
• Push it out, so you are not drawing down capital before you need it
• Drawdown the debt 3-6 months before your cash runway runs out
• Otherwise, you are paying a lot of interest and amortizing the loan, and it’s not helping your runway

The primary reason for startups taking on venture debt is to get enough funding to extend your runway and hit some of your milestones. However, you need to be aware that by borrowing money too early, you’re incurring interest expense for funds you don’t immediately need. For example, a startup with 20 months of funding might be encouraged to borrow money and get a term sheet for a loan that requires the startup to draw down the loan in six months. That’s well before you actually need the money. Founders should be careful to structure the loan so they can access it when the startup has about six months of runway left.

Typically venture debt loans have a couple of different repayment options: a flat interest rate or deferred interest with a final payment option. And while this question feels very critical, the actual math on the internal rate of return for the cost of this capital works out to be just about the same with either option. In general, pushing out the payments will allow you to use those funds for other purposes, so that might be better for your situation. If you think you will be able to prepay on the loan, a flat interest rate may be the better option.

Negative pledges on intellectual property (IP) are an agreement between venture debt lenders and startups that borrow from them. The negative pledge prohibits the borrower from creating any commitment that includes the borrower’s IP. That ensures that the IP remains unencumbered and available to satisfy debts if the borrower defaults on the loan agreement.

The amount of cash your startup should keep in the bank has become an important question since interest rates start rising. Your bank wants you to keep as much as possible with them, but they may not be offering competitive rates. If you have a loan or letter of credit, you may be required to keep a certain amount in the bank you borrowed from. It’s often specified in your term sheet. But we are seeing more startups negotiating with banks, and asking if they can keep 50 or 75 percent of their funds in the bank, rather than 100 percent.