Venture debt buys time at a fraction of the dilution of an equity round. It is also the wrong instrument for a company with no visible path to its next round. Here is how to tell which situation you are in.

What venture debt is

Venture debt is term funding for a venture-backed company, sized against the last equity round rather than against EBITDA. Tenor is typically two to three years, repayment is usually amortising after a short interest-only period, and the lender takes a small equity kicker in the form of warrants alongside the interest.

It exists because conventional bank credit is underwritten against historic cash flows and tangible security, and a fast-growing, asset-light, pre-profit company fails that template however creditworthy it actually is.

How much, and at what cost

Facilities are commonly sized at 20% to 30% of the last equity round, though this varies widely with the lender and the visibility of revenue. Pricing sits well above bank credit, it has to, because the lender is taking equity-adjacent risk with debt-shaped returns, and the warrants only partly compensate.

The right comparison is therefore not rate against rate. It is the all-in cost of the facility, warrants included, against the dilution of raising the same amount in equity. On that comparison venture debt is usually much the cheaper capital, which is the whole reason the instrument exists.

The three situations where it works

  • Extending runway to a milestone. The classic use. You are four months from a metric that will materially reprice the next round, and you have nine months of cash. Venture debt buys the gap without setting a valuation today.
  • Funding a specific, self-liquidating need. Working capital for an inventory build, or equipment for a new facility, where the asset or the cash cycle repays the facility. Here the debt is matched to something that generates the cash to service it.
  • Topping up a round. Adding 20% to a completed equity round at a fraction of the dilution, when the round was sized tightly and one more hire or one more market would change the trajectory.

The situation where it makes things worse

A company with no visible path to its next round is almost always made worse off by venture debt. You have added a monthly debt service obligation to a cash problem, shortened the runway you were trying to extend, and introduced a creditor who ranks ahead of every equity holder in a downside.

The test is simple and worth applying honestly. After the debt is drawn and the instalments begin, does the remaining runway get you to a milestone that a reasonable investor would fund? If the answer is no, the problem is not solved by borrowing, and an adviser who tells you otherwise is not doing their job.

Terms to read carefully

  • The warrant. Expressed as a percentage of the facility, converted at the last round price or the next round price. The difference between those two conversion bases matters a great deal if you are about to raise up.
  • Material adverse change. A broadly drafted MAC clause lets the lender decline to fund an undrawn tranche precisely when you most need it. Narrow it.
  • Covenants tied to the equity round. Some facilities accelerate if a subsequent round does not close by a date, or closes below a threshold. That converts a growth instrument into a cliff.
  • Prepayment. Check whether you can repay early without penalty when the next round closes, which is the ordinary exit from the facility.

The alternatives worth pricing alongside

Revenue-based financing repays as a fixed share of monthly collections rather than a fixed instalment, so it flexes with a bad month. It suits subscription and platform businesses with predictable revenue, and removes the fixed-obligation problem that makes venture debt dangerous in a downside.

Structured credit against a specific asset or contracted cash flow can be cheaper than venture debt where such an asset exists, receivables, promoter shareholding, or a contracted revenue stream.

Working capital limits from a bank or NBFC are cheaper than all of the above, and a company with real receivables and inventory often qualifies for more conventional credit than it assumes. It is worth testing that before reaching for a venture debt term sheet.

Before you sign

Model the facility into your cash flow with the instalments in place, and check the runway you are left with rather than the runway the headline amount suggests. Our EMI tool will work out the instalments for you. More detail on the instrument set is on our venture debt and structured credit page.

This article is general information, not lending, tax or legal advice. Statutory positions and lender practice change. See our terms of use, and talk to our team for advice on your own situation.