Venture Debt Term Sheets — What to Negotiate
Venture debt — loans extended by specialty lenders to venture-backed and growth-stage companies — has become a standard part of the capital toolkit. The headline interest rates look reasonable. The full economics are more complex. Below is what to read carefully before signing.
The basic structure
Term loan, typically 3-4 years. Interest rate of Prime + 2% to Prime + 7% depending on credit. Interest-only period (usually 6-18 months) followed by principal amortization. Backed by warrants on the company’s common or preferred stock. Often coupled with a small revolving facility for working capital.
The headline interest rate isn’t the cost
Venture debt cost includes interest plus three other components:
1. Origination fees. Typically 0.5% to 1.5% of facility size, paid at closing. Adds to effective yield.
2. End-of-term payment (“backend” or “final” fee). Typically 3% to 8% of facility paid at maturity or refinance. Substantial — often more meaningful than annual interest in total cost.
3. Warrant coverage. Typically 0.5% to 1.5% of facility in warrants, exercisable for 7-10 years at the last preferred round price. Equity dilution. Can be material in successful exit scenarios.
All-in effective cost: usually 12-20% IRR to the lender. Compare honestly to equity, not just to bank debt.
The covenants that matter
Cash burn covenants. Most venture debt requires minimum cash balance, sometimes specified as “minimum runway” (cash divided by burn rate must exceed X months). Breach can trigger default.
MAC (Material Adverse Change) clauses. Subjective language allowing the lender to declare default on perceived deterioration. Read carefully; negotiate to tighten the definition.
Equity raise milestones. Some venture debt requires the borrower to raise a defined amount of equity by a defined date. Missing the milestone can trigger acceleration.
Information covenants. Monthly financials, board materials, customer concentration reports, sometimes management cap-table updates. Higher reporting burden than standard bank debt.
What to negotiate
- Interest-only period. Longer is better — preserves cash during growth phase.
- Backend fee. Lower; cap at 4-5%.
- Warrant coverage. Lower or remove; if warrants required, push for “fully diluted” rather than “as-converted” calculation.
- MAC clause language. Tighter, objective triggers preferred over subjective lender determination.
- Cash covenants. Negotiate floor levels and trailing measurement periods.
- Prepayment terms. Allow prepayment without penalty after defined period.
- Subsequent equity rounds. Pre-approve the lender’s consent or right of first refusal mechanics.
When venture debt makes sense
- Bridging between equity rounds to reduce dilution
- Funding specific capital expenditure (equipment, infrastructure) with defined ROI
- Extending runway when an equity round is in process but not yet closed
- Funding inventory build for known committed demand
When venture debt doesn’t make sense
- Filling working capital gaps caused by operational issues (debt cures don’t fix underlying problems)
- Funding growth that requires equity-scale capital with no clear path to profitability or next round
- Businesses where the cash covenant is likely to bind in any reasonable downside scenario
- Bridging to an exit that depends on uncertain inflection points
The diligence question worth answering before signing
Model your business 12-24 months out. In your downside case, does the cash covenant hold? Does the backend fee crowd out a future equity round? Do the warrants meaningfully dilute existing equity? If the answer to any is “yes,” reconsider the size or terms of the facility.