Google. Facebook. Uber. Dropbox.
What do they all have in common?
Apart from the obvious—they’re all booming businesses—they’re also some familiar names that took out venture debt on their paths to success. Billions of dollars of it, to be precise.
Venture debt is a way to fuel business advancement without giving up equity. When harnessed effectively, it can be a valuable tool for extending your runway and managing cash flow between investment rounds.
In this article, we run through venture debt as a financing option for startups and small businesses that don’t qualify for traditional loans. We explore:
- What venture debt is, along with its benefits and drawbacks
- When businesses should and shouldn’t take out venture debt
- How venture debt differs from other types of loans and financing options
- What venture debt lenders look out for when considering businesses for loans
- How to choose the right venture debt lender for your startup
While you’re likely not eligible for the same amount of venture debt as some of these top unicorns, this type of financing could be the helping hand you need to reach your next funding round and, ultimately, success.
Let’s go.
What Is Venture Debt?
Venture debt, also known as venture lending, is a type of financing that doesn't require giving up ownership of the company. It’s typically a loan provided to startups with existing investors or growing companies that need capital to expand or become profitable. Generally speaking, startups can apply for a venture debt loan of 20-40% of their latest equity round—but the decision always depends on the lender.
Startups use this loan type to fund efforts like:
- Hiring talent
- Marketing campaigns
- New product development
- Equipment acquisition
- Refinancing existing debt
- Paying dividends to shareholders or owners
- Extending runway until the next financing round
It’s important to note that venture debt is not always 100% non-dilutive. It may be supplemented with warrants, which give lenders the option to buy shares in the future at a pre-agreed price. This is why you may see venture debt referred to as a semi-non-dilutive funding option.
Warrants aside, venture debt is a helpful option for early-stage companies that need funds but don’t qualify for standard loans or don’t want to further dilute equity with another investment round (more on this later!).
Here’s how startup funding rounds usually unfold and where venture debt fits in.
How Venture Debt Fits into the Startup Funding Timeline
Although a viable financing option for early-stage companies, venture debt is not available for startups until a certain point in their journey. This is how it usually goes:
1. Pre-seed and Seed Funding
In the earliest stages of a startup, founders raise funds from a variety of sources. For example, some founders may receive funding support from friends and family and/or professional connections they've made throughout their careers.
Following this initial phase, founders often seek additional funding from investors to accelerate their startup's growth. These investment rounds are called seed funding and are typically used for initial development efforts, like market research, prototyping, and operational expenses.
2. Venture Capital
After the first seed funding rounds that get the startup wheels turning, it’s time to scale. To achieve growth, a lot of startups exchange equity for capital. This is called venture capital financing.
Venture capital (VC) is a form of private equity financing that funds new companies with high growth potential in exchange for company shares. This type of funding dilutes the equity of the startup, meaning multiple people will have an ownership stake in the company. With this type of startup financing, the capital comes from specialized VC investors such as:
- Individual venture capitalists (angel investors): People who invest personal funds in startups they believe in
- Venture capital firms: Companies with high business and technical acumen that pool funds from institutional investors, wealthy individuals, and corporations to invest in high-growth startups
VC funding can happen at any time during startup development—from initial seed investments to later-stage growth funding stages, such as Series A, B, and C rounds.
3. Getting Venture-Backed and Qualifying for Venture Debt
Once a company gets venture capital funding, they are venture-backed (VB). The VB title gives startups more credibility and trustworthiness. It’s proof that industry experts believe in the product/service, management team, and growth potential of the company.
With this trust badge on hand, startups can seek the help of venture debt lenders for financing.
Venture Capital vs. Venture Debt: Clearing Up the Differences
The main difference between venture capital and venture capital is that the first is a loan and the other an investment. In short:
- Venture capital is money received from investors in exchange for ownership
- Venture debt is a loan provided to early-stage startups that have difficulty getting traditional loans
Venture capital comes first, and venture debt (sometimes) follows.
Venture Capital Is a Partnership That Dilutes Equity
Venture capital isn't just money, it's ownership, and, as such, brings investors into the decision-making process.
VC investments are risky as are offered to companies based on growth presumptions and forecasts rather than proven records of past financial success.
To minimize risk, capitalist investors provide more than just their money. They bring their expertise, knowledge, and technical know-how to the table to help the startup reach the peaks of success. They often have a role in managing the startups in the early stages.
Venture Debt Is a High-Interest Loan That Startups Need to Pay Back
Venture debt is a bank, or other lending institute, taking a risk based on the trust invested in a startup by venture capitalists.
Unlike venture capital investors, venture debt lenders don’t ask for equity in exchange for money. Their funding comes in the form of a high-interest term loan that founders pay back over a set period of time—which could be anywhere from a year to four years.
In addition to loan repayment, interest, and other fees, venture debt lenders may receive warrants. Warrants give lenders the right, but not the obligation, to buy shares at a predetermined price, regardless of future increases in the company's valuation when it becomes successful.
Although venture debt is a financing option that can take the form of a loan, it's different from traditional loans in terms of risk, interest rates, flexibility, additional fees, and more.
How Is Venture Debt Different from Traditional Loans?
Venture debt stands out from traditional loans in several ways, let’s take a look:
Conditions
Venture Debt
Granted based on the startup's potential to raise capital.
Traditional Loan
Granted to established businesses with proven financial records of profitability.
Eligibility Criteria
Venture Debt
More flexible eligibility criteria, that typically include market opportunity, recent equity rounds, cash flow and projected cash burn rate, revenue and profitability.
Tradicional Loan
Strict qualifying criteria, that typically include creditworthiness, annual revenue and profit, debt-to-income ratio, collateral, and more.
Use
Venture Debt
Used to supplement venture capital funding, not as a stand-alone financing solution.
Traditional Loan
Can be a standalone financing option that helps startup founders with bigger-scope projects (buying property, expanding operations, or consolidating debt into one loan with better interest rates).
Lender Risk
Venture Debt
Venture debt lenders take on higher risk since the startups they fund have little or no collateral.
Traditional Loan
Traditional loans pose lower risks for lenders thanks to stricter requirements (strong credit history and collateral)
Interest
Venture Debt
Higher interest rates.
Traditional Loan
Lower interest rates.
Flexibility
Venture Debt
More flexibility and quicker access to funds.
Traditional Loan
Stricter requirements and approval processes.
Additional fees
Venture Debt
Can include:
- Interest rate: in the 10-15% range
- Closing fees: typically around 1%
- Warrants: starting from approximately 1-2% dilution, with some funds requiring 2-5%+
Origination fees: typically around 1% of the full loan
Traditional Loan
Vary greatly by loan type and can include:
Often, startups and small businesses don’t meet the qualification criteria to be considered for traditional loans, so they apply for venture debt instead. However, that’s not to say venture debt isn’t worthy of being a first pick.
Despite its high interest rates and additional fees, venture debt is an attractive option for startups thanks to the many benefits it comes with.
How Does Venture Debt Benefit Businesses?
The main advantages startups can harness when accessing venture debt loans include:
- Company ownership: offers access to additional capital without (significant) equity dilution
- Cash runway extension and financial safety: provides longer financial independence between funding rounds and can be used to cover unexpected costs
- Higher valuation: when used to achieve growth objectives, it can increase the startup’s valuation for the next round of funding
When should businesses choose venture debt?
Christian Rasmussen, CFO at Cledara, shares some thoughts on when’s a good time for small businesses and startups to consider venture debt:
“Companies should consider taking out venture debt when:
- They are cash-flow positive and need to support growth initiatives without diluting equity
- They require short-term capital to bridge funding rounds or finance specific projects
- They want to extend their runway before the next equity raise to achieve better valuation”
Venture debt can be a powerful tool for early-stage businesses, but it doesn't come without some risks.
What Are the Risks of Venture Debt?
Although it can be a great financing tool, venture debt doesn't come without drawbacks:
- Restrictive debt covenant: Lenders often impose repayment agreements that set minimum financial conditions, such as imposed revenue milestones, a specific ratio of debt to equity, or sales targets. If startups fail to meet these conditions and default on the loan, the lenders could initiate forced liquidation.
- Repayment dependent on future funding rounds: Startups that are yet to become profitable will have to rely on future investment rounds to pay back the loan
- Lower chances of attracting investors: Because repayment often comes from future investment, it can hinder a business’ chances of attracting investors—who prefer to invest in growth initiatives rather than paying back existing debt—in future funding rounds
The key to minimizing the risks of venture debt is to ensure you don’t use it to postpone addressing business challenges or financial issues, as we heard from Christian.
When should businesses avoid venture debt?
“It is not advisable to take on venture debt when:
- The company is not cash-flow positive, as the obligation to repay debt can strain finances
- The business lacks a clear path to profitability or stable revenue streams to service the debt
- The market conditions are uncertain, which could jeopardize the ability to meet debt obligations and raise new equity financing ”
Sound like venture debt could be a fit for your growing startup? Then it’s time to see if you might be eligible, here’s what venture lenders look for when evaluating companies for venture lending.
How Do Venture Debt Lenders Evaluate Companies?
Prior to the 2023 Silicon Valley Bank crisis that disrupted the venture lending market, the emphasis on backer quality was very high. Now, following the crisis and the overly inflated startup valuations that led to it, venture lenders have stopped relying so heavily on VCs' expertise and reputation to make their decisions.
It’s still a consideration, just not as important as it previously was. Instead, lenders get a holistic view of the business and the market within which it operates. Here’s how modern venture lenders assess startups and their associated risks.
They Assess the Company’s Venture Capital Investors
Although nowhere near as important, being VC-backed is still a consideration for lenders. The logic behind it still stands: if a startup struggles to get funded, chances of it becoming profitable are low, and the risk for lenders is high. It’s not the only consideration by far, but being VC-backed gives an initial positive impression to lenders.
They Consider the Company’s Growth Stage, Potential, and Performance
To identify good investments, lenders perform due diligence checks on startups. This process involves an in-depth analysis of aspects like:
- Financial history: Checking multiple financial key performance indicators, statements, and documents, including income statements, balance sheets, cash flow statements, financial projections, and existing debt, among many others
- Legal standing: Assessing shareholders and equity percentages, compliance with the law, liabilities, and legal claims against the startup
- Product: Evaluating the maturity of the product, its market fit, the value it delivers to customers, and what makes it different from the competition
- Business model: Appraising the company's scalability potential
- Founder and key-role stakeholders: Determining management's level of experience and relevant credentials
These background checks and due diligence processes have become stricter in determining venture lending eligibility since 2023 and have a lot more weight than the quality of backers.
They Consider the Industry in Which the Company Operates
During their deliberation, lenders will also look at the performance of the relevant industry as a whole. They’re looking to see if the industry is growing, and whether conditions are conducive to the individual business’ success (and, subsequently, loan repayment). A brilliant product in a thriving market is a lot more attractive than a brilliant product in a stagnant one.
However, it’s not just down to lenders to choose you—you also choose them. Venture debt lenders differ greatly, and you want to find a lender that suits your needs. Here’s how.
How to Choose a Venture Debt Lender: 3 Key Considerations
Venture debt providers come in all shapes and sizes. Some have hundreds of companies and years of experience under their belt, whereas others are newer and less experienced. Different venture debt providers will also offer different terms and conditions on the loan they provide.
Let’s look at each of these points in depth.
Evaluate the Lender’s Reputation and History
Before you start submitting venture debt applications, you should make a list of lenders that:
- Are familiar with your industry
- Offer flexible repayment options
- Have positive references from other companies
- Have proven experience with startups at your stage
This helps eliminate lenders that don’t meet your needs from your consideration process.
Research the Lender’s Behavior During Economic Downturns (and Economic Prosperity!)
You need a lender that works with you through good times and bad. When choosing a lender, ensure you know how they act when startups face challenging times. To do this, read through online reviews, research industry articles, and reach out to companies that have previously done business with the lender to ask about their experiences.
The goal of these referencing efforts is to gauge the level of support and understanding the lender provides when things take a turn for the worst. Do they collaborate to find a solution that works? Are they empathetic in their business relationships? All very important when times are tough.
Alongside this, you also want to consider how they act when life is good. Are they willing to revise terms if the business performs better than expected? Are they open to more funding when the time is right? These additional perks can be the deciding factor for many startups.
Once you’ve gone through the first round of consideration and excluded lenders with a poor reputation, you can start pitching your business and applying for loans. The research is not done yet, however. You will still have to do more assessment with the offers you receive.
Evaluate Key Loan Terms and Conditions
Following your applications, you'll start receiving term sheets covering key terms and conditions of your loan. The most important ones you should evaluate include:
- Loan size: the actual sum you get from the lender
- Loan duration (maturity): the time frame in which you have to pay the loan back
- Total loan price: the interest, fees, and warrants associated with the loan
- Interest-only period: the time it takes to cover the loan’s interest
- Amortization time: the time it takes to cover the principal, after the initial phase of paying only interest
- Covenants: the conditions you need to meet to avoid loan default (examples include minimum cash balance, revenue targets, and regular financial reporting)
- Repayment plan flexibility: the options you have to pay the loan back when issues arise (for instance, restructuring the loan to give your repayment plan more leeway until you're back in steadier waters)
- Milestone events: the objectives you need to hit to get a better deal (for example, if your startup achieves a set financial milestone, the lender might increase the debt capital and give you more money)
Christian, Cledara CFO, also highlights a couple of additional aspects worth considering:
- “Fit with business model: Ensure the lender’s approach aligns with the company’s growth strategy and business model
- Support and resources: Determine if the lender provides additional resources or support beyond capital, such as networking opportunities or strategic advice”
If evaluating these terms on your own feels overwhelming, consider collaborating with startup advisors and lawyers specializing in venture debt.
Once you identify the lender offering you the best deal for your needs, all that’s left is to sign on the dotted line.
Consider Venture Debt for Your Early-stage Startup
Ultimately, whether venture debt is a good idea or not depends on the startup's growth trajectory and financial stability. It’s a great way to access funds without equity dilution, but it can be risky for startups that aren’t yet profitable—as repayment puts a strain on finances.
In the right circumstances for the right business, venture debt is a valuable financing tool that enables game-changing startups to thrive. If your business is cash-flow positive, VC-backed, and currently between funding rounds—venture debt might just be the additional cash injection that you need.
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