We can help you through every step of the process: from understanding key terms to getting the best deal.*
We’ll help you compare existing and new offers from a variety of lenders. You’ll have the freedom and advice to make the best decision for your startup. No information is shared without your consent.
Venture Debt Fetch allows you to compare all aspects of your term sheets. Get insights based on our years of debt & lending experience. Choose the perfect venture debt offer that aligns with the needs of your startup.
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Using state of the art technology and industry expertise, we will analyze your first term sheet for free.* We can help you through every step of the process: from understanding key terms to getting the best deal.
Venture Debt Fetch connects startups to the best banks and lending funds, then analyzes the 1st term sheet for free!*
Haim Zaltzman & Ben Potter of Latham & Watkins discuss startup funding strategies including the benefits and differences between Growth Equity & Growth Debt.
Latham & Watkins
Patrick Johnson of Silicon Valley Bank (SVB) stops by to talk about Startup Banking, Venture Debt, and the other ways SVB partners with founders and and investors to support innovation.
VP, Tech Banking
Silicon Valley Bank
Aaron Tyler, Managing Director at TriplePoint Capital, discusses Venture Debt for Startups
Watch all Venture Debt Videos from Kruze Consulting
Material Adverse Change clauses are another ambiguous term that lenders use to create an Event of Defaul. Once a startup is in default, the 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.
One of the most ambiguous and dangerous event of defaults for a startup. This term is typically used by a bank to create an event of default if the company is not performing. The Bank 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.
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.
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 Advance Rate on Receivables is the percent of eligible receivables a bank will give a startup. Most banks will advance 75% to 80% of an eligible received balance. This creates some margin for error for the lender should the company struggle and a portion of the Accounts Receivable proves uncollectable.
A venture lender does not like old receivables, customer concentration or foreign receivables. Therefore the lender will generally limit the amount one customer or a group of customers, like foreign customers, can make up of the overall receivable balance for the startup that they are lending to. Customer concentration limits are usually around 20% - 30% of a receivable base. After subtracting out old receivables, customer concentration and foreign receivables, the startup is left with a $ amount, or borrowing base, that the lender will advance a percent against.
Venture Lenders realize startups want to extend runway and pay back as little of principal as possible. Therefore lenders will grant interest only periods, usually the first 6 to 12 months of a loan, where the startup is only paying interest on the loan. This period is usually timed to end right after a fundraise will take place. The logic is the startup will be flush with equity capital after the fundraise and will be in a position to start paying back the loan.
Successful startups typically raise future rounds at higher and higher valuations, meaning future capital is less dilutive, or "cheaper" than current capital. Therefore, lenders 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.
An Accounts Receivable Line is a type of debt financing based on an advance of the eligible accounts receivables outstanding. Inexpensive debt because Accounts Receivable is really strong collateral. Banks typically control the startups cash too which is a second form of collateral.
A flexible but expensive loan product. A Growth Capital Line is not tied to specific collateral like a Accounts Receivable, but instead collateral will be all of the startups assets. Including Intellectual property into the collateral is negotiable. Often a negative pledge on IP is negotiated meaning the startup cannot pledge the IP as collateral to another lender, but the growth capital lender does not have a lien in the IP. The lack of IP lien can dramatically slow the foreclosure process, so the startup should avoid pledging the IP whenever possible.
Lenders has a lien on All the Assets including IP, they can foreclose much quicker because they don't have to give notice to other creditors. They are the sole beneficiary in a liquidation. Therefore they can foreclose in 10 - 15 days. If the bank had "All Assets except IP," then it's more like a 45 - 90 day process.
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.
A venture loan is typically available for a fixed amount of time. The draw period outlines the dates by which the borrower must pull down the loan. Often a specific amount of debt must be drawn before an initial draw period ends. If the initial draw is completed, then the remaining loan balance might have an extended draw period into the future.
Lenders want to control the total amount of debt a company carries because 1) the lenders don't want to over-leverage the company and 2) if the lender is not secured in all the assets including Intellectual Property, then the lender must split the proceeds of the sale of assets where a full lien is not secured with the other unsecured lenders. Therefore, Lenders will often dictate how much other debt a startup can take on and often insist it is subordinate debt.
Lenders build large portfolios of startups, and like all investors, want to get more ownership in the very best startups. Therefore they will often ask for the option to invest a specific amount of equity in future rounds. Letting the venture debt firm have too much of your next equity financing round can cause problems if the round is over-subscribed, so be careful with this term.
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.
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.
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.
WTI is unique in that in the event of a pre-payment, WTI will ask a startup to pay the future interest that would have been paid in future years. There is no discount on future interest for pre-paying a loan. In fact, it's worse for the startup because the future interest is paid earlier in the loan amortization period so the effective interest rate is actually much higher. Startups typically only do this if they are refinancing into a bigger loan or have raised a lot of equity. Note that because WTI requires the payment of all future interest, the loan is much less attractive to pre-pay. Therefore the borrower is much more likely to stick with WTI and put a larger loan in place rather than refinancing and going with a new lender. WTI's pre-payment language helps it retain the best borrowers.
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.
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!
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!
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.
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 Consulting loves Silicon Valley Bank (SVB) and First Republic. These banks specialize in startups. Their customer service is fantastic and their online banking systems are great which makes it easier for us and lowers your bill. If you need a referral to SVB or First Republic, 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 (SVB or 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!
In Venture Capital, everyone is playing for the home run outcome. However, in a smaller exit, liquidation preferences allow VC's to get their money back before Common Stock owners, usually Management. Here is a simple example: A startup raises $4M in Preferred Equity with a 1x liquidation preference. When the company is sold, venture capitalists can choose between receiving their original $4M investment back, or converting to Common and participating with all the other shareholders on a pro-rata basis. If they choose the return of investment, then their investment basically functioned as a loan. Liquidation preferences are an important tool for VC's because it mitigates risk. In those scenarios when the startup isn't a huge exit but does get purchased, the VC's get their money back and can distribute the capital back to their Limited Partners. If an investment achieves a big exit, the VC's will almost always convert, thereby forgoing their liquidation preference, so they can participate alongside other investors and management. Liquidation preferences are very common in VC investments. Most of the time, VC's get a 1x preference, but in tough situations, they might ask for 2x or 3x liquidation preference. However, anything more than a 1x is rare. The essence of a liquidation preference is that VC's get their money back in a modest exit. In a big exit or an IPO, VC's will always convert to participate in the big upside.
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.
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.
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.