Venture debt is a form of typically provided by certain lenders to venture-backed companies that lack the assets or cash flow for traditional bank debt financing. Venture debt is generally structured as a term loan that is paid down over time—usually 3 years. Venture debt is typically senior to other company debt and is collateralized by all of a company’s assets. Unlike traditional bank debt, venture debt typically does not include financial (such as a requirement to maintain a minimum amount of cash in the company’s bank account), though the interest rates on venture debt are typically higher than traditional bank loans (generally, ranging from 10% to 15%). In addition, a venture lender typically receives a to purchase of the company. A warrant is like a stock —it provides the holder with the right to purchase shares of stock (common or preferred) of a company at a fixed price for a period of time. A warrant issued to venture lender is typically exercisable for preferred stock with an exercise period of 5 or 10 years.
A key consideration for a venture lender as it analyzes a potential loan to an early stage company is whether the company has closed at least one round of equity financing with venture capital firms and/or other . In fact, a venture lender’s decision to extend a loan to an early stage company is more based on the reputation and stature of the venture capital firms and/or other institutional investors in the company than the creditworthiness of the company. The venture lender is relying on these institutional investors to continue to fund the company past the of the loan. Thus, a venture lender will spend a fair amount of time meeting with the institutional shareholders of the company as part of the venture lender’s approval process for the loan, and they will typically prefer to loan money to companies backed by venture capital firms with whom the lender already has had prior business relationships.
The principal benefit of venture debt is that it is largely non-dilutive to the existing shareholders of a company (other than the resulting from the exercise of the warrant). That is, the venture debt provides capital to the company while not significantly reducing the percentage of ownership of existing shareholders. The downside is that venture debt must be repaid, so the company will need to have the cash or cash flow to pay off the loan. The risk is that if the company does not execute on its plan, the venture lender may seek to have the loan repaid before the end of the term of the loan—precisely when the company does not have the cash to repay the loan.