Is Venture Debt Right For Your Business

In this video, you'll learn about venture debt, which is a loan given to an early-stage company to help it stay afloat between equity funding rounds.

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Additional Resources

youtube.com/watch?v=aVAZvhXwlZY
youtube.com/watch?v=f9dtgRdikTQ
youtube.com/watch?v=gxr_eMAKiTM

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The main focus and the reason why you would take venture debt like additional debt capital on top of your venture capital equity, is you want to extend the runway. The only thing that matters is extending the runway of the company so that you have enough time to hit all your milestones and raise a big up round. Those milestones are critical. It's what gets the next round of investors interested in the company. And when you hit those milestones, you can negotiate a great term sheet, right? So sometimes people take venture debt, or the only reason to take venture debt really, is because you can buy yourself another three six months of runway to hit those milestones and negotiate a great deal.

So always just, it drives me crazy when I see, you know, a less sophisticated team effectively being taken advantage of by a lender. And what happens is they raise a bunch of equity just to make the numbers simple. Let's say they raise $10 million of equity, and a bank or a fund says like, oh, this is amazing. We'll give you some venture debt, incremental capital, which is exactly how to do it. And you should always put this in place pretty close to when you raise the money because there's no adverse selection for the lender, no asymmetric information at that point. And then the term sheet comes in and it's like, you know, "We know you have 20 months of cash, startup. We'd like you to draw the money down in the next six months."

And so if you do the math there you've got 20 months of cash, but the latest you can draw this money down is six months from now. Which means you are going to make 14 payments back to the lender before you hit your cash out date. And actually the debt will extend your cash out date a little bit, even though you're still kind of borrowing your own money in this example. So maybe you make 15 payments back to the bank. Well, most deals are, you know, 36 months of amortization with some interest only. And so we start doing the math here, you've paid a significant amount of the debt back by the time you hit your normal cash out date and actually are going to use the money. That's not a coincidence. The lender wants you to do that. The lender is trying to get off risk as fast as possible. They're collecting interest, and their goal is to get paid back. This is a lending business for them.

And so your goal as a founder should be to structure a term sheet that gives you a long forward commitment, that has you drawing the cash down maybe like six months before the cash out date, maybe three months. I don't like to cut it too close because there is always the potential for like an adverse event to happen for the company. And you may fail the funding MAC requirement. Like any lender's basically going to say, hey, we have to check things out and make sure everything's kosher before we let you draw the money down. So you don't want to cut it too close. Like, if you try to like... The example would be you draw it down on the last day. If you're really trying to maximize everything and not pay the money back as long as possible, you could draw it down the last day before the offer or the commitment is extinguished. But don't do that. That's too risky. Give yourself three to six months. I vote for six months.

But if to avoid borrowing your own money, structure something where you can draw the money out, way out there, with like six months of runway still remaining. Otherwise, a huge amount of the cash you're paying back is happening before your cash out day. And you're really kind of minimizing your runway extension. And you're basically, you're not really getting any benefit from the debt. All you're doing is making a bank or a lender some money along the way. They're not really taking any risk. You're not getting any benefit. Why do it, right? So if you can't get that forward commitment, then just don't do the debt because it's not going to add enough runway to make it worth with your while. So hope that helps.

Author

Ariyani

Como educador, estou profundamente engajado no desenvolvimento dos estudantes em ambiente escolar, adotando métodos pedagógicos que valorizam conexões genuínas e são movidos por inovação e fervor. É minha vocação guiar os alunos na jornada de se tornarem uma geração notável, empregando estratégias de ensino amplamente aclamadas por prestigiadas instituições acadêmicas ao redor do globo - events.zulekhahospitals.com