Venture debt, or venture lending, gives funding to startups so they can expand without selling shares up front. Founders might use venture debt alongside equity financing to pay for new projects or cover costs before the next investment round. Like other commercial loans, venture debt comes with repayments, lending costs, and other terms that can affect how you run your business.

Below, we’ll discuss how venture debt works, when it can fit in a startup’s funding strategy, how it compares with equity financing, and questions to ask potential lenders.

Key takeaways

• Venture debt typically supplements equity financing to help startups fund growth without selling more shares up front.

• A loan agreement explains how much you can borrow, when funds will be available, and how you’ll repay the loan. The agreement also covers other loan conditions that might apply, such as a lender’s right to buy shares.

• When considering venture debt, compare lenders’ terms, including total borrowing costs, repayment schedules, and the consequences of missed payments or breached conditions. Repayments are due even if growth or fundraising is slower than expected.

What is venture debt?

Venture debt is a loan for startups that have raised money from investors and need additional funding to grow.

Unlike venture capital, with which investors receive an ownership stake, venture debt provides cash without requiring founders to sell equity up front. The company agrees to repay the money with interest, although some lenders also receive warrants that give them the right to buy shares later.

For example, a software startup might use venture debt to hire engineers to develop a new product that could attract more paying customers. The extra funding gives the startup time to demonstrate demand before its next funding round, but loan repayments continue even if the release takes longer than expected.

In the US, startups obtain venture loans from specialist lenders and banks that work with new businesses. These providers recognize that a startup might spend more cash than it generates and can consider the startup’s investors, cash projections, and prospects for further capital when assessing its ability to repay.

How does venture debt work in practice?

Venture debt works through a loan agreement that sets how much you can borrow, when you can access the money, how much you’ll pay, and other conditions you agree to meet.

Here’s a closer look at how venture debt works:

Loan amount

Loan amounts vary depending on the business. Lenders often offer 25%–35% of the amount raised in the company’s most recent equity round. For example, if your company raised $10 million during Series A, you might obtain $2.5 million to $3.5 million in venture debt. The startup’s financial position, spending plans, and existing investors also influence the offer.

Instead of providing all the money up front, lenders might issue it in portions, called tranches. Some funds might be available immediately, while accessing the rest depends on reaching a specific revenue target or other milestone.

Interest and fees

Interest rates reflect the risk a lender takes in financing a startup. Rates can be fixed or variable. Some agreements include a payment-in-kind (PIK) option, which adds the interest to the loan balance instead of requiring an immediate cash payment. PIK reduces cash outflows in the short term but can increase the overall amount to be paid.

Fees can include charges for arranging the loan, repaying it early, or reaching the end of the loan agreement. A lower interest rate doesn’t necessarily mean a less expensive loan. Consider the total cost of the loan before borrowing.

Repayments

The agreement specifies the repayment schedule and when the remaining balance becomes due. With amortizing loans, you’ll repay a portion of the total amount borrowed alongside interest each month. With nonamortizing “bullet” loans, you’ll pay only the interest each month and make one payment covering the principal at the end of the loan period. Monthly payments might be lower in the short term, but businesses need to prepare for the larger payment when it’s due.

Many loans begin with an interest-only period before moving to payments that include principal and interest. Monthly payments can increase when principal repayments begin, leaving less cash for other activities.

Warrants

Venture lenders can sometimes benefit if your startup grows in value. Some lenders receive warrants, which give them the right to buy shares at an agreed price within a certain period. This means venture debt can still dilute ownership even though founders aren’t selling equity up front.

The loan still must be repaid in full even if lenders exercise their warrants. This differs from a convertible note, with which the debt can convert into shares, or a simple agreement for future equity (SAFE), which gives an investor rights to future shares without creating a loan you must repay.

Covenants

Lenders can attach covenants to loans to reduce their risk. These are conditions a borrower agrees to meet, such as maintaining a minimum cash balance, reaching revenue or growth targets, and providing regular reports to the lender. The agreement might also limit further borrowing or prevent the company from selling assets. Breaching a covenant can lead to penalties or prompt the lender to demand earlier repayment.

When does venture debt make sense for startups?

Venture debt can make sense when a startup needs extra time or funding for a specific purpose, provided it can make repayments. For example, you might use venture debt to:

• Extend time between fundraising rounds while completing a product release or waiting for market conditions to improve.

• Buy inventory or hire staff to meet demand as the company grows.

• Reach a milestone that supports a higher valuation so you can reduce how much ownership you give up in the next equity round.

Venture debt can be difficult to obtain without venture capital backing and might not suit a startup that would struggle to repay the loan if growth slows or unexpected costs arise. In those situations, other funding options could be a better fit.

Venture debt vs. equity financing: What’s the difference?

When deciding between venture debt and further equity financing, the main factors to consider are dilution of ownership, cost of capital, repayment obligations, and level of risk.

If revenue is uncertain and you’re still testing demand, equity can provide more flexibility. Investors also have a stake in the business and can offer founders advice, industry contacts, and help with hiring.

Startups often use both. Realistic forecasting can help you determine how long equity alone would last, and then you can compare that outlook with a scenario that includes venture debt.

What risks should founders consider?

Venture debt comes with risks for borrowers, particularly regarding managing repayments and loan conditions. Some of the key risks include:

• Pressure to repay: Repayments leave less cash for growth, so the loan might not provide as much extra time as expected. Payments continue even if sales slow, while faster growth can use more funding and make repayments challenging.

• Less flexibility: Covenants can introduce restrictions that limit your ability to change plans.

• Debt can affect future financing: Prospective investors might hesitate if their funding will be used to repay debt.

• Defaulting on your loan: Not meeting financial and reporting obligations can lead to a default even if repayments are up-to-date.

These risks can be more difficult to manage for young startups with limited revenue. More established businesses might have other revenue streams, but expanding business activities and unexpected market conditions can still put pressure on cash.

What questions should founders ask potential venture debt lenders?

Before entering into a venture debt agreement, ask lenders to explain the key terms. Here are a few useful questions to raise during due diligence:

• How much money can my company access, and when? Ask what conditions apply to future tranches and when the draw period ends.

• What is the full borrowing cost? This might cover interest rates, fees, legal expenses, and early repayment charges.

• Will payments increase, and when? Request a repayment schedule to understand how payments will be split over the loan period.

• What warrants apply? Check the number of shares, purchase price, expiration date, and potential dilution.

• Do any covenants apply? Ask how lenders monitor and test loan conditions and which scenarios require the lender’s consent.

• What happens if a payment is late or a covenant is breached? Confirm whether there is time to correct a breach if a problem occurs.

Lender terms vary, so comparing multiple term sheets from different venture debt providers can help startups find the right option. Legal counsel and financial advisors can support the decision-making process before you sign.

How Stripe Atlas can help

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FAQs about venture debt and how it works for startups