While there’s no shortage of lenders that provide venture debt, it’s important to keep in mind that they don’t all work the same way. Companies need to do their homework to understand the structure and terms of any potential debt financing to ensure it’s the best solution for their business and fits with their longer term capital-raising strategy.
Where possible, partner with a lender that:
- Offers capital efficiency. Being required to draw down the entire amount of the loan up front can mean the company is paying interest on excess capital it cannot invest effectively, which is inefficient. Instead, consider loan structures that allow the company to draw down capital as required.
- Doesn’t require amortization. Rather than being strapped with the burden of immediately having to pay back a loan, look for lenders that offer the option of interest-only loans over the entire term, with the principal due in full upon maturity.
- Is flexible. You want the ability to increase funding as your business grows and to prepay your loan without penalty. Most venture debt facilities are fixed in their size, leverage ratios, and term. A lender with rigid policies and large prepayment penalties could impede a business’s ability to execute on its strategic plan and its ability to raise additional capital in the future.
- Has a transparent all-in cost structure. Different venture debt providers take different approaches to pricing deals. In addition to an annual interest rate, that may include upfront fees, administration fees, standby fees, early prepayment fees, and warrants, among other costs. When it comes to venture debt, transparency and simplicity trumps opaqueness and complexity.
- Doesn’t have excessive or highly restrictive covenants. True venture debt should generally have fewer covenants than traditional senior or working capital loans as it’s meant to work as growth capital and bear more risk (and should be priced accordingly). In addition, venture debt covenants should be appropriate for companies that are using capital to fund growth and that are often generating no operating cash flow. Beware of senior loans masquerading as venture debt with excessive covenants that increase the risk of defaults and restrictive covenants that reduce the capital that’s actually available to be drawn down.
- Understands the venture growth journey and has a proven appetite for risk. The right venture debt provider should have a proven track record of being borrower- and founder-friendly, and of behaving well when things don’t go according to plan. While the lender has a fiduciary responsibility to safeguard the capital it has loaned, a seasoned and rational lender will work with the company to overcome challenges and help ensure the optimal outcome for all business stakeholders.
What you need to know about warrants
If you’re looking at venture debt that includes warrants, pay attention to:
- The formula for calculating the number of warrants the lender will get, and the strike or purchase price for the warrants
- How long the warrants will remain outstanding
- If the lender has an option to force the borrower to redeem the warrants or the shares purchased by exercising the warrants (known as a put option)
- Any anti-dilution clauses associated with the warrants or underlying shares
Finding a venture debt partner that’s able to provide a loan structure that meets your particular needs and objectives is critical for ensuring a successful financing. To learn more about venture debt and how it works, check out “Venture debt: An alternative growth financing option.”