Venture Debt: The New Kid on the Block🤙🏽

If you have been working in any capacity related to fundraising, you probably heard about Venture Debt.

Unless you've been living under a rock.

With $27.5 billion raised in 2020, venture debt became quite popular when several VC-backed companies needed to extend their runway and meet short-term liquidity needs with the pandemic. Startups needed capital to survive the lockdowns, but they didn’t want to go through more dilution.

But what makes venture debt special? Venture debt is a loan that gives the lender the option to acquire shares of the borrower on its following fundraising round at a discounted rate. This is typically used as a complementary method to equity raising.

The lower cost of capital of this option, and also the relative simplicity of execution of due diligence and terms negotiation, are among the main reasons for the rise of venture debt.

Below I summarize the main terms of a traditional Venture Debt term sheet:

1. Warrants: Venture lenders are compensated with the company's warrants (options to acquire a certain amount of shares) on equity for the future fundraising rounds that the borrower may avail. The ticket size for the warrant is usually equivalent of 5% to 20% of the loan amount.

2. Duration: The duration of a venture debt loan varies between 3 to 4 years and the amount is usually capped at 30% of the last round of equity fundraising.

3. Interest rate: varies. But it’s usually a premium on what is the risk free interest rate (LIBOR, T-bonds, etc.). You shouldn’t expect anything higher than 8% per annum.

4. Size: Usually attached to the latest equity round you raised. Ranges from 5% to 20%.

For the lender, this is an interesting option in terms of returns. They are able to enjoy the interest rate and the appreciation of the company’s shares in the next fundraising round, at a discount.

So just to recap: venture debt requires the borrower to be in the VC-fundraising route, as the main benefit for the lender is the potential appreciation of their investment with the option to acquire shares at a discounted valuation. It's also usually available to startups that have some history of operations but not enough cash flow to be eligible to avail traditional loans with banks.

Venture debt should not be compared to other two types of debt financing that are also increasingly popular: revenue-based and convertible notes. The former doesn't require additional equity fundraising rounds, and the latter can be extremely dilutive due to the discounts and valuation caps. We will have an article dedicated to each debt financing option to explain in further detail.

---

🎧 Podcast recommendations

▶️ Founders Field Guide: Dave Girouard - Making Better Loans: Imagine what happens when ex-Googlers decide to build a lending company. What happens? Upstart happens. Dave Girouard guides us in the journey of building one of the most incredible fintechs in the world (for those of you that don’t know, I’ve been working as a fintech-exec for the last 5 years, and I get a little nerd out with the topic 🤓 )

▶️ Acquired - Michael Mauboussin Master Class: the title of the podcast says it all. A masterclass on all-things-investing-related by the one & only Professor Mauboussin - who is the current lecturer of the classic Benjamin Graham course in Columbia Business School for securities analysis.

---

This is Open Books - a weekly newsletter carefully curated by me, Leticia Souza. Every week I’ll be compiling relevant topics around finance and financial strategy - from choosing your first accounting system to how to successfully close a fundraising round to your business.

In a world full of noise, I aim to bring clarity and direction to your finance processes so you can manage your business in peace. If you find the content useful, do your friends a favor, and please share this newsletter with them.

See you all next week 👋🏼

Leticia