What Is Venture Debt, How Does It Work, And When To Use It?

If you’re finding barriers to getting the extra financial help you need to scale (especially if you're a new company without credit history), you're probably wondering:

  • What’s the best financial option for your company’s growth stage?
  • How to finance growth when you don’t have enough revenue or assets to access debt and you want to avoid dilution through venture capital?
  • How to access capital quickly to bridge your VC rounds or break even when both equity financing and debt are time-consuming and restrictive?
  • What is venture debt and can it really help you scale? 

We interviewed Jeeves’ in-house financial experts to help you make an informed decision on venture debt and other options. Our article will cover:

  1. What is venture debt and why use it?
  2. How does venture debt work? 
  3. How can startups raise venture debt?
  4. When does it make sense to use venture debt?
  5. When does it make sense to use an alternative to venture debt?

Key takeaways:

  • Venture debt financing is a form of semi-dilutive capital for VC-backed companies, usually in their early or growth stages.
  • While venture debt is more flexible than traditional financing, it can also come with restrictions like covenants and warrants.
  • It’s common for entrepreneurs to receive help securing venture debt from a known lending partner of their VC backer.
  • You can use venture debt for growth, to increase your company's cash runway and as a bridge between equity rounds.
  • Other options may be more beneficial than venture debt.

What is venture debt?

Venture debt is a cross between a traditional bank loan and venture capital (VC) and is extended to VC-backed companies that need extra liquidity. Venture debt is financing that usually takes the form of a loan, but not always. 

Also known as venture lending, venture debt is commonly used by VC-backed early and growth-stage startups to:

  • Inject capital to help business growth.
  • Extend their cash runway in between funding rounds without diluting the business.

However, even later-stage VC-backed companies and private equity-back businesses can tap into venture debt financing, especially when they need an extra cash flow boost to break even or become profitable.

Example of when to use venture debt to extend your cash runway between rounds of equity
Example of when you can use venture debt to bridge or replace a round of equity and extend your cash runway

Why use venture debt?

Venture debt is more forward-looking than traditional debt. 

Traditional bank loans will underwrite your company based on metrics like past performance and credit history. But most early-stage companies haven't been in business long enough to meet these requirements, even though they have successfully raised equity. 

With so many barriers to entry with a bank loan, many early-stage companies can apply for venture debt immediately after an equity funding round. Venture debt lenders will underwrite you based not just on past equity but on your potential for growth.

You can also use venture debt if you’re in a growth stage. Perhaps you’re focusing on building up your revenue first and on the verge of break even or profitability. Venture debt financing provides a boost to your runway to scale your business. 

How does venture debt work?

It’s common for venture debt providers to put certain financial covenants in place to incentivise repayment. Covenants are a set of agreements made between the borrower and lender that outline the criteria or behaviour that the lender must fulfil for the loan to progress.

For example, the borrower might not always be given the full amount of the debt all at once. You might be approved for $3 million but have only $1 million dispersed to you initially. For the lender to disperse the next $1 million, perhaps you have to hit a specific revenue or growth target for the remaining $1 million. 

Some companies can negotiate venture debt without financial covenants if they are well-capitalised or high-growth businesses. 

Warrants may also come with a venture debt agreement. This is where the lender has the right to purchase equity in a company at a later date. Warrants offer downside protection and upside potential for the lender.

For example, let's say you don't hit your goal of raising another round or can’t repay your debt. In these cases, the lender can buy equity, which will be more valuable when the company reaches their subsequent funding round.

Warrants are viewed as a deal sweetener for the lender. However, they are typically small at 2% of the company’s valuation,  much less than venture capital equity agreements. 

Venture debt terms

Venture debt lenders are the senior secured lenders in a company’s capital stack — meaning you would repay them first because they’re at the top of the stack. The caveat is if you also have a bank loan, which means the bank is the first on the stack and you would pay them first.

Here are the most common venture debt terms:

  • The length of the loan term can vary from 24 months to 48 months, with an industry average of 36 months. This amount of time can provide you with enough runway to reach your subsequent funding round.
  • The amount of venture debt received is generally between 25 - 50% of the amount previously raised through a VC company. 
  • The price of financing venture debt is higher than a loan, as there is more risk. You’ll pay the principal and interest payments, but there is no set standard for interest rates.

You can negotiate a balloon loan structure with your lender in some situations. This is where you pay interest only or nothing until the loan matures, at which point you pay the remaining balance all at once. Balloon loans are useful if your company has high expenses and you’re confident you can raise a substantial next round of funding. 

How can startups raise venture debt

To raise venture debt, startup founders have multiple financing options. Banks and non-bank lenders offer venture debt, and there are also specialised venture debt lenders for specific niches.

One of the most common ways to acquire venture debt is through referral. This is because many VC firms have access to their own venture debt lenders. As they regularly do business together, there is trust, and they will simply refer the company they just backed to venture debt lenders.

What do you need to apply for venture debt?

To apply for venture debt, you'll be using many of the same financials you show to venture capitalist firms. So for convenience, apply for venture debt and VC funding simultaneously as you have all the documentation already.

Also, look for venture debt funds when you have just raised capital; this is when your financials look the best. If you wait and have far less money in the bank, you might not secure enough debt to hit your next round.

Just like applying for venture capital, with venture debt, you will need to show the following:

  • A summary. Showing what you do and what makes you unique.
  • Market fit. What problem you are solving and how you will solve it.
  • Business model. Explain your business plan and outline your sales and marketing strategy.
  • Team profile. Explain who the management team is and who you have in place to fulfil the work.
  • Financials. What your current finances look like and show the company growth projections, outlining revenue and profit.
  • Capital needs. How much you need and how you plan to use the capital. It can include what milestones you plan on achieving with the capital provided.
  • Repaying the debt (venture debt only). Your business goals for being able to repay the debt and what happens if you can’t repay.

Need some help in crafting your product or service's value prop? Find inspiration with our post, 11 Powerful Value Proposition Examples & Why They Work.

What are venture debt lenders looking for?

Venture debt lenders prefer venture-backed businesses because this indicates the company is well capitalised, which increases the likelihood of successful repayment. Venture debt lenders will also want to know who your VCs are, including their experience and how much they will advise the company.

The team behind the company is a critical part of the acceptance process. The lenders will enquire as to their expertise and how capable they are at managing a team to deliver on their business plans. 

Lenders will want to see that you have a proven revenue model and strong product fit in a large market. And more importantly that you have a high probability of scaling your business into high-profit margins. 

They will look at how you plan to operate, communicate and share data together. Also, it’s essential to show how you will manage the combination of corporate interests of investors, managers and staff to provide clear communication for all. 

When does it make sense to use venture debt?

The most common use cases for venture debt are to help the company grow and to bridge the gap between funding rounds. 

Here’s when it can also makes sense to use venture debt:

  • Keep the dilution of your company down by using venture debt in conjunction with venture capital. For example, instead of getting $5 million from VC at 25% dilution, you might receive $4 million in VC at 20% dilution and $1 million in venture debt.
  • Maintain company control by using venture debt for early stage rounds over venture capital. You will have more say in your company’s decisions in the long term. And you don’t want to give up too much equity early on as there won’t be much left by series D or E.
  • Create a credit record early through venture debt so you’ll be eligible for bank loans in the future. This is useful if your company has low revenue and low assets, as you would be deemed too risky for bank loans. 
  • Extend your startup runway to meet slower growth targets as venture debt loans are available for up to 48 months. 

Who benefits the most from venture debt?

SaaS is typically an excellent industry for venture debt because of the recurring revenue and the monthly or annual company contracts. 

Their scalable business model also makes them very sellable and more lucrative to invest in. Venture debt firms will see the potential, whereas a bank might deem them too risky.

Other technology companies without assets or a track record can benefit from venture debt also. 

Your venture capital investors will also like to see you take on venture debt instead of too much venture capital investment. It benefits these early investors because it minimises equity dilution. 

When does it make sense to use an alternative to venture debt?

The traditional alternatives to venture debt are venture capital or traditional debt.

In this section, we’ll first summarise the three most common forms of debt in a comparison table: venture debt, venture capital and traditional debt. 

What is venture debt chart

When to use venture capital over venture debt?

VC firms will invest in your company based on potential and venture capital has fewer requirements than venture debt. Here’s when it makes sense to use venture capital over venture debt:

  • You’re still in seed stage. If your company is still in seed stage, start fundraising for venture capital before venture debt. Some venture capital firms won’t want to see a lot of their investment going straight to pay off debt, which might deter them from investing. Also, it’s more straightforward to get venture debt once you have equity capital, which is why you should look at venture capital first.  
  • You want fewer short-term expenses. Venture debt is paid back in monthly instalments, whereas venture capital equity is only paid back by selling your company’s shares.
  • You prefer to have experienced advisors to help you grow. Equity investors will sometimes get a seat on your company’s board and can become great advisors to startups. You can leverage this by finding someone who knows your industry or business model well and can help your company excel or guide you during financial hardships, like managing your startup during a recession
  • You need substantial amounts of capital. You won’t be able to acquire the same large amounts of funding from venture debt as you would with venture capital. You can typically use venture capital for larger initiatives like building a product, expanding internationally, or opening offices, as it’s one of the most expensive forms of debt.

When to use debt financing vs venture debt

There are two main types of debt financing: traditional loans and digital debt. Both may require you to have positive cash flows before they can extend a line of credit. 

Use debt financing instead of venture debt when you don’t plan on becoming a high-growth massively scalable company and are too small to access venture capital. If you’re not a VC-backed company, you most likely can’t access venture debt. 

You can also choose debt financing when you want to:

  • Pave your way to profitability. If you’re focused on the fundamentals and want to build a business, debt financing is the right choice. 
  • Have both short and long-term options open to you. With debt financing you can choose a short-term loan to buy supplies or stock up on inventory or long-term financing for bigger deals or assets like mergers, acquisitions, or machinery. 
  • Pay less. Debt is cheaper because it’s short term and you’re only paying back interest, not losing shares of your company. 

Speed is the main difference between venture debt, traditional debt lenders and digital debt providers. Commercial banks can take months to finalise a loan whereas digital debt providers like Jeeves can fund you in a few days.

Finance your company with venture debt (or its alternatives)

We hope this article provided insights on what venture debt is, how it works and when it's best used. 

As we mentioned, other options might suit your company better depending on your size and stage, with venture capital also providing significant benefits. 

If you're a growing company looking for a financial operating system built for global businesses, try Jeeves