Venture debt is a loan to a venture-backed company, usually from a specialist lender or a bank's technology group. Used well, it extends runway past the next milestone with less dilution than equity. Used as a substitute for equity, it adds fixed payments to a company that may not be able to make them.
What lenders underwrite
| Factor | Why it matters |
|---|---|
| Recent equity round and investor quality | The lender is partly relying on investors to fund the company again |
| Cash runway | The loan should not be the only thing keeping the company alive |
| Recurring revenue and retention | ARR quality and NRR support repayment |
| Gross margin and burn efficiency | Signals of a path to sustainability |
| Financial reporting | Timely monthly statements and a credible forecast |
Clean books and a forecast that ties to them shorten the process considerably.
Terms to model
| Term | What to check |
|---|---|
| Commitment and draw period | How much, and when it can be drawn |
| Interest-only period | Months before principal payments begin |
| Interest rate | Usually floating, often with a floor |
| Amortization | Months of principal and interest after interest-only |
| Final payment or end-of-term fee | A percentage of the amount borrowed, paid at maturity |
| Warrants | Equity coverage for the lender |
| Covenants | Minimum cash, revenue performance, reporting deadlines; some loans are covenant-light |
| Material adverse change clause | Lender's right to call the loan |
| Prepayment fees | Cost to refinance or repay early |
A worked cash view
A company draws $3,000,000 with 12 months interest-only at 12% and 24 months of amortization.
| Period | Monthly payment (approx.) |
|---|---|
| Months 1–12 | $30,000 interest |
| Months 13–36 | About $141,000 principal and interest |
That second-phase payment must sit inside the 13-week forecast and the operating model, with covenant headroom shown in the downside case.
The accounting
- Loan proceeds are recorded as debt, net of issuance costs, which are presented as a reduction of the carrying amount.
- Warrants are recorded at fair value at issuance. Depending on their terms, they are classified as equity or as a liability under ASC 480 or ASC 815. Their value creates a debt discount.
- Discounts, issuance costs and the final payment fee are amortized into interest expense using the effective interest method.
- Covenants are tested and disclosed; a breach can make the debt current on the balance sheet.
Before signing
- Model the debt in both base and downside cases.
- Confirm covenants can be met with room to spare.
- Read the material adverse change and default provisions with counsel.
- Agree the monthly reporting package the lender expects.
We prepare the financial package lenders ask for, model the terms in the operating model, and book the loan, warrants and interest correctly at each close.
Sources
- FASB Accounting Standards Codification, Topics 470 (Debt), 480 and 815
- U.S. Small Business Administration, Loans
Questions founders ask
When is venture debt a good idea?
Usually right after an equity round, to extend runway to a clear milestone. It is risky as a substitute for equity when the company has no path to its next raise or profitability.
Do warrants issued to a lender affect the books?
Yes. Warrants are recorded at fair value when issued, usually as a discount to the loan that is amortized into interest expense over the loan's life.
