Sample Venture Debt Term Sheet

This is the amount that will be lent to you.

This is the amount of time your startup can draw upon these funds. If availability begins at a set date rather than “close’’ remember that it will take approximately a month to go through documentation. Your startup should put a loan in place well before you need it based on your burn rate and runway. We recommend putting a loan in place after an equity fundraise and drawing it down later. Getting a loan at that point is easier and you’ll get better terms. Most loans will have a long forward commitment of six to 18 months for the startup to draw the money down.

Please note that it’s better to draw the money down when your startup has some months of cash in the bank, rather than waiting until you are out of cash. Generally, your startup should draw the funds when you have about 3-6 months of cash available. If funds get tight and the bank has a Funding Material Adverse Change (MAC) clause (see On-Going Conditions) the bank could deny you funding that your startup was counting on.

During the interest-only period your startup can draw on the funds and only pay interest instead of loan amortizing payments as well. Interest-only periods are attractive because minimal capital is paid back to the lender during that time, which means the startup can use the capital. Please note that we don’t advocate waiting until the last minute to draw down funds. Note that in the current environment, interest rates are rising. Many startups ask for fixed rates, but banks and lenders are sophisticated and generally insist on floating rate deals. Note that banks and lenders do not let rates float below the interest rate stated when the deal was struck.

Milestone events are often included in a deal to bridge the startup’s requests and the lender’s concerns. For example, a lender might decide it can extend the Interest Only Period or include more debt capital in a deal if the startup hits the Milestone. The startup knows that by hitting the Milestone, it gets a better deal so both parties benefit from the inclusion of a Milestone if there is a gap in negotiations. If the startup fails to achieve the Milestone, the lender rarely takes a negative action. The deal just reverts to the more conservative option. Lenders take negative actions when Covenants are breached which will be discussed later.

Amortization of a loan means that Principal and Interest are paid back to the lender on a defined schedule. In this case, it’s 36 months but it will be shortened if the startup hits the milestone because the interest-only period will be extended.

Typical loan durations are 3-4 years.

The commitment fee compensates a lender for providing access to a loan. The lender is allocating, or holding, capital for the startup. Commitment fees are notoriously easy to negotiate down. The commitment, prepayment, and final payment fees all affect your startup’s cost of capital. We recommend getting several term sheets and reviewing the terms. You can use that information to negotiate the best deal.

Normally venture debt lenders will charge a small prepayment fee of 1-3% of the remaining principal outstanding. If there is a “Final Payment” component of the loan, that will also be due at the time of prepayment. The lender always wants to keep money outstanding and earning interest with strong companies. However, strong companies tend to prepay their loans. The prepayment fee ensures that the lender gets some return on the funds if they are prepaid. Prepayment fees, like commitment fees, are often easy to negotiate down.

A final payment lets the lender “backload” some of the loan’s interest and startups find this attractive. In general, it’s better for your startup to delay interest with a final payment than making larger payments during the term of the loan. It’s better to backload because three or four years after the startup puts this loan into place, it should be raising capital at a much higher valuation. Raising at a much higher valuation means that the percentage of the startup that would need to be sold in an equity fundraise to pay the debt is much lower and less dilutive.

These are assets that are pledged to satisfy the loan if it goes into default. Typically a lender will request a lien on all assets of the company. The lender will benefit from the liquidation of assets if the company goes into default and a restructure can not be reached. A fallback position for the lender is to ask for a lien on all assets except for intellectual property. In that case, the lender will ask for a negative pledge on intellectual property (IP). The negative pledge means that the startup is prohibited from pledging its intellectual property to another lender. The negative pledge does not count as an actual lien, and if the company is sold, any proceeds from an IP sale are split among all the creditors. If the startup asks for a restructure later, it can offer to convert the negative pledge on intellectual property into an actual lien on IP.

Covenants are conditions to which the startup must adhere. Violating covenants puts the startup at the risk of default. When negotiating a loan a startup’s goal should be have as few covenants as possible in the term sheet. If any covenants are included, the startup should be sure it can clear those covenants.

While all covenants can be a problem for startups, revenue covenants can be particularly worrisome. If the startup misses its revenue, it will probably have an accelerated burn rate as well. The accelerated burn rate means the startup’s cash balance will shrink much faster than predicted. Once your startup misses a revenue covenant, you’re in default and at that point you have to play by the lender’s rules. In general, we advise clients to negotiate those out if possible. Affirmative covenants are goals your startup must achieve. Negative covenants restrict startups from taking certain actions, like borrowing more money or incurring liens.

The Material Adverse Change (MAC) clause gives the lender the right to call a default and the ability to seek remedies if an event adversely affects your financial position. 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. Once the startup is in default, the lender can pursue remedies like foreclosure.

The bank will continuously review your financial position and if the burn rate is out of control, it can call a MAC default. We’ve seen lenders reference changes in the fundraising climate, large lawsuits, changes in management, etc as reasons to call a MAC default. MACs are ambiguous and therefore give the lender a lot of latitude to interpret and call a MAC default.

Investor Abandonment Clause (or Investor Support Clause) is another covenant that functions like a MAC but relies on the VC investors’ willingness to put more capital into the startup. The lender can call a startup’s investors to determine their level of commitment and whether they will invest more into the startup. If the company isn’t doing well or the investors don’t plan to provide more funding, the lender can call a default.

The Funding MAC is less severe than a full default, which could put the startup into foreclosure. The Funding MAC gives a lender wide latitude to refuse to allow the startup to draw more funds. While the Funding MAC is not a full default, if the startup is counting on those funds, it could have a very serious negative effect on the startup. Try to negotiate Funding MACs out of the term sheet, but if you can’t get one removed from the term sheet, consider drawing all the money up front or early in the loan to avoid the Funding MAC.

The reporting section outlines the information your startup is regularly required to submit to the lender. You should have a startup CPA firm like Kruze Consulting prepare your monthly financial reports for your lender.

The lending bank will expect your startup to conduct cash management banking through the lender. This is a standard clause, since having your deposits protects the lending bank. They can use those assets to offset your startup’s debt if you go into default (the “Right of Offset”).

Warrants grant the lender the right to buy your company’s stock at a guaranteed price. The lender will typically hold the warrants and wait for the startup to do an IPO or be sold for a significant gain. At that point the lender will exercise the warrants. Typically half of the warrant is based on the commitment of the loan, and half is based on drawing down the loan. A venture debt loan warrant is part of the cost of the loan. To evaluate that cost, you’ll need to look at your valuation. We recommend determining the actual stock you will be giving up and dividing that by the loan amount. That gives you an effective warrant coverage percentage. In general, 20-35 basis points is standard, with half vesting when the loan closes and the other half when your startup first draws funds. Fund lenders tend to charge a higher warrant coverage.

Basic legal and due diligence expenses are noted on the term sheet. You can ask the lender to cap the documentation expenses for the deal. If the deal expenses are not capped, the lender’s law firm can run up a higher legal bill than necessary.

Due diligence is performed after a term sheet is signed, but the details are often spelled out on the term sheet. Typically a bank lender’s credit committee or a fund lender’s partner- ship must approve the deal.