Venture debt

What it means

Venture debt is a loan for venture-backed startups that complements a funding round and extends the runway, the time the company's cash will last. Unlike another equity round, it does not significantly dilute founders and investors.

It is provided by specialised funds or banks focused on growth companies. Since startups often have no profits and few assets to pledge, the lender relies mainly on the backing of reputable venture capital investors who are expected to keep funding the company.

Venture debt is more expensive than an ordinary bank loan. Besides interest it includes fees and often options or warrants giving the lender the right to acquire a small stake in the company at a pre-agreed price. The lender thus shares in the company's potential success.

How it works in practice

Companies usually take on venture debt shortly after a successful funding round, when they have plenty of cash and investor support. The loan helps them reach further milestones, such as higher revenue, and thus secure a better valuation in the next round.

The money is used, for example, to finance growth, buy equipment, expand into new countries or as a buffer through an uncertain period. The loan is typically repaid in instalments after an initial interest-only period.

Venture debt is a hybrid form of financing, like mezzanine financing. When deciding, it is useful to compare the total cost of the loan, including warrants, with the cost of dilution from issuing new shares.

What to watch out for

The loan agreement contains covenants and conditions that can restrict the company, for example on further borrowing, asset sales or bonus payments. If the company misses its growth plan or fails to raise the next round, it may struggle to repay, and the lender may demand immediate repayment.

Debt must be repaid regardless of how the business is doing. For startups with an uncertain future, venture debt therefore increases risk. It should be used to accelerate growth in a company with a clear plan, not to rescue one that cannot raise equity from investors.