What is venture debt?
Takeaway: Venture debt is a specialized form of loan provided to venture-backed startups; it is a powerful, non-dilutive tool used to fund specific capital needs, but it comes with the serious risks and covenants of traditional debt.
As your startup grows, you will discover that equity financing is not the only source of capital available. A second, parallel track for funding your company is through debt. For a venture-backed company that does not have the positive cash flow required for a traditional bank loan, the most common form of debt is venture debt.
Venture debt is a specialized type of term loan provided by a small number of banks and non-bank lenders that focus exclusively on the startup ecosystem. It is a powerful tool for extending your runway and funding specific types of expenditures without diluting the ownership of your founders and investors.
How is Venture Debt Different from a Bank Loan?
A traditional bank lends money based on a company's assets and its history of profitability. A venture debt lender, on the other hand, is underwriting a different kind of risk. They are lending money to a company that is often unprofitable, and they are often doing so based on the credibility of the company's venture capital investors.
The venture debt lender is betting that the company is on a strong growth trajectory and will be able to successfully raise its next round of equity financing. This future equity financing is the source from which the debt will ultimately be repaid.
The Structure of a Venture Debt Deal
The Loan: A venture debt deal is typically a term loan that must be repaid over a set period, often 24 to 36 months.
The Security Interest: Unlike a convertible note, a venture debt loan is almost always secured by a "blanket lien" on all of the company's assets, including its intellectual property. This gives the lender the right to seize the company's assets if the loan is not repaid.
The Warrant Coverage: In addition to interest payments, the lender will also receive a "warrant" to purchase a small amount of the company's stock. This warrant coverage is the lender's "upside"—it allows them to participate in the success of the company and compensates them for taking on the high risk of lending to an unprofitable startup.
The Role of Venture Debt in Your Capital Strategy
Venture debt is not a replacement for venture equity; it is a complement to it. It is not meant to fund your primary R&D or your day-to-day operating losses. Instead, it is a tool used for specific, targeted purposes, such as:
Extending Your Runway: Providing an extra 6-9 months of cash to allow you to hit a key milestone before raising your next equity round.
Financing Capital Expenditures: Funding the purchase of expensive lab equipment or the build-out of a new facility without having to use your dilutive equity capital.
Financing Working Capital: Providing a bridge to cover a short-term gap between your expenses and your customer revenue.
Venture debt is a sophisticated financial instrument that can be a powerful tool when used correctly. It allows you to be more efficient with your equity and can reduce overall dilution for you and your team.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.