Venture debt is a loan to a venture-backed startup, usually made soon after an equity round, that adds runway without selling more stock. It makes sense when you have a specific use for the cash and a credible path to repay it, such as reaching a higher-priced next round, buying equipment or financing receivables, and when institutional investors stand behind you. It costs more than the interest rate suggests: expect fees, warrants, monthly reporting, restrictive covenants and a lien on nearly everything the company owns.
Key takeaways
- Debt dilutes less than equity, but it has to be repaid on schedule whether or not your next round happens.
- Venture lenders lend against your investors’ backing more than your cash flow, so most want an institutional VC behind you.
- The real cost is interest plus upfront, final payment and prepayment fees, warrant coverage (often 5% to 15% of the loan) and the lender’s legal fees.
- Negotiate at the term sheet: draw conditions, IP collateral, subjective defaults and banking requirements are hard to change later.
- Get a competing term sheet, and check your charter and investor agreements for consent rights before you sign.
Should a startup borrow or raise equity?
Equity is permanent capital. Nobody can demand it back, but every share you sell is ownership you give up for good. Debt is temporary capital. It dilutes far less, but principal and interest come due on a fixed schedule, and if you can’t pay, the lender can take the company’s assets.
| Feature | Venture debt | Equity |
| Repayment | Yes, on a fixed schedule | No |
| Dilution | Small, through the lender’s warrant | Large, through the shares sold |
| Cost | Interest, fees and warrants | Ownership and investor rights |
| Control | Covenants and a lien on company assets | Board seats and protective provisions |
| If things go badly | Default, and the lender can enforce against assets | Investors share the loss |
Borrowing beats selling equity in a few situations. The most common is extending runway to hit milestones, so your next round happens at a higher price. Others are financing equipment, smoothing working capital against receivables, or building a cushion in case a round takes longer than planned. Borrowing is a poor fit when the only way to repay is a next round you aren’t confident you can raise. Debt shortens your margin for error, because the payments continue even when fundraising stalls.
Why do venture lenders care so much about your investors?
Most venture-backed startups lose money, so a venture lender isn’t counting on profits to repay the loan. It’s counting on your next equity round, and on your investors continuing to support the company. That’s why lenders look first at who led your last round and how much you raised, and size the loan as a fraction of that equity. It’s also why many loan agreements make it a default if your investors signal they won’t keep funding the company.
The best time to borrow is right after you close an equity round, when your cash balance is high and your investors are committed. Lenders compete harder then, and you can negotiate from strength.
What types of venture debt are there?
Term loans. A fixed amount for growth, often with an interest-only period of about 12 to 18 months, followed by monthly payments of principal and interest over the remaining term, which is commonly three to four years in total.
Tranches. Many term loans fund in pieces. The first tranche is drawn at closing, and later tranches become available only if you hit conditions, such as raising a set amount of new equity or reaching a revenue target by a deadline. Check that the conditions are realistic and the draw windows long enough.
Revolving lines of credit. You borrow, repay and borrow again, up to a borrowing base calculated as a percentage of eligible receivables or recurring revenue. Revolvers fund working capital, not runway.
Equipment financing. A loan secured by the equipment it buys.
What does venture debt really cost?
Example. These terms are illustrative, not market quotes. A company that just raised a $15,000,000 Series A at $1.00 per share borrows $3,000,000. The loan has a floating interest rate that works out to 11%, 12 months of interest-only payments and then 24 months of equal principal payments. It carries a 0.5% upfront fee, a 4% final payment fee and warrant coverage of 8%.
Over three years, the company pays about $674,000 of interest, a $15,000 upfront fee and a $120,000 final payment fee, about $809,000 in total, plus the lender’s legal fees. The lender also gets a warrant for $240,000 worth of Series A preferred at $1.00, or 240,000 shares. Raising the same $3,000,000 in equity at the Series A price would have meant issuing 3,000,000 shares. The debt is far less dilutive, but the company must repay $3,000,000 plus about $809,000 on schedule, whatever happens to its next round. See Stock Warrants.
What’s in a venture debt term sheet?
The term sheet sets the deal. The loan documents that follow are much longer, but they rarely move far from what the term sheet says, so negotiate here.
Amount and draws. How much, how much at closing, and the conditions and deadlines for later tranches. Many companies prefer not to draw everything at once, to avoid paying interest on cash they don’t need yet.
Interest and repayment. The rate, usually floating and tied to the prime rate, with a floor. The length of the interest-only period and whether it extends if you hit a milestone. The maturity date.
Fees. An upfront or commitment fee, sometimes a good-faith deposit paid at signing and credited at closing, a final payment fee due when the loan is repaid, and a prepayment fee if you pay early, which should step down over time. Lenders expect the company to pay their legal fees, so ask for a cap.
Warrants. Coverage as a percentage of the loan, the class of stock (usually the last round’s preferred), the exercise price, the term and what happens in a sale. Push for coverage based on the amount actually drawn, not the full commitment.
Collateral. Lenders typically take a first-priority lien on substantially all company assets. Many will exclude intellectual property from the lien in exchange for a negative pledge, a promise not to pledge the IP to anyone else, which also leaves you free to license it. Expect a lien search, and if any existing lender has a lien, it will need to be paid off or subordinated.
Covenants. Reporting covenants, usually monthly financial statements, annual financial statements, an annual budget and sometimes board materials. Negative covenants that require the lender’s consent for more debt, new liens, acquisitions, dividends and a sale of the company. Financial covenants, such as a minimum cash balance or performance against your plan. Early-stage loans often have no financial covenant, and that’s worth asking for.
Events of default. Missing a payment, breaking a covenant and defaulting on other debt are standard. Two subjective defaults deserve the closest reading. A “material adverse change” default lets the lender declare a default if it decides your business has deteriorated. An “investor abandonment” default is triggered if the lender concludes your investors won’t keep funding the company. Ask for cure periods for covenant breaches and narrow, objective language for any subjective default. After a default, the lender can charge a higher interest rate, demand immediate repayment and enforce its lien.
Banking requirements. Many lenders require you to keep your main accounts with them, or to sign control agreements over accounts held elsewhere. Since the 2023 bank failures, it has become standard to negotiate the right to keep some cash at another bank, commonly enough to cover at least two payroll cycles.
What approvals and diligence does venture debt require?
The board must approve the loan and the warrant, and reserve shares for the warrant. Check your charter and investor agreements, because protective provisions often require the consent of a majority of preferred stockholders to borrow above a set amount or to grant liens. See Protective Provisions.
Lenders run diligence too: the cap table, financial statements, material contracts, and confirmation that the company owns its IP through signed CIIAAs and contractor agreements. If your records are in order from your last round, this goes quickly. See Startup Due Diligence.
How should founders negotiate venture debt?
Get at least two term sheets, because competition moves terms more than argument does. Decide what matters most to you before you negotiate. For most startups that’s flexibility on draws, no or narrow subjective defaults, cure periods, a negative pledge on IP instead of a lien, warrant coverage on drawn amounts, a prepayment fee that steps down, room to bank elsewhere and a cap on lender legal fees. Then ask your lead investor what they think. They will have seen these deals before and may know the lenders.
Go deeper: For the equity side of your financing, see our Founder’s Guide to Series A and Founder’s Guide to Seed Funding. For other ways to fund a company, see Venture Capital 101 and Startup Funding Stages.
If you’ve received a venture debt term sheet, see our contract review service or contact us.
