Strategy & Timing: When to raise venture debt FAQs
Maximize leverage by timing your raise correctly, navigating market downturns, and aligning with your board.
6
questions
answered
When should startups take venture debt?
It’s common knowledge that one should raise funding when it can, not when it needs it. Often, by the time you actually need funding for your tech company, the window may have closed due to macro events or challenges within your own business. This is why serial entrepreneurs and experienced CFOs start talking to lenders immediately in paralel of closing an equity round or signing major contracts.
Most venture debt structures do not require you to take the full amount upfront. A smart approach could be to secure financing on favorable terms while your business looks strong, withdraw only the minimum you need now, and keep the option to draw more funds later as needed.
Is venture debt risky in a downturn?
Yes, downturns increase insolvency risk across the market. Venture debt is not immune.
That said, experienced lenders underwrite for difficult scenarios from day one. They price risk conservatively, run downside sensitivity analyses, and size facilities with stress cases in mind. Strong lenders also expect companies to have a credible “Plan B” if growth slows or capital markets tighten.
Importantly, venture debt is rarely managed in a vacuum. In challenging periods, lenders often work constructively with founders and equity investors - extending maturities, providing temporary payment relief, or restructuring terms to stabilize the company and maximize long-term recovery for all stakeholders.
Like any leverage, venture debt increases risk but when structured prudently, it can remain a useful tool even in volatile markets.
Taking venture debt during equity fundraising, is it practical?
Venture debt during fundraising has become increasingly popular, as equity rounds often take longer than expected and sometimes raise less capital than planned. In these situations, companies may turn to debt to avoid cash-flow shortfalls, which might impact the valuation, while their equity round is still in progress.
The ideal timing is usually after a company has secured a lead investor for the equity round but before the round has closed. In this scenario, lenders perceive lower credit risk and can offer more favorable terms.
If a company has a short runway but no lead investor yet, the credit risk is higher, since the equity round has a higher chance to fail. This typically results in more expensive debt terms.
Can venture debt hurt future equity rounds?
Generally, debt and equity can complement each other. Debt is typically a financial tool used to improve liquidity temporarily, while equity represents a long-term partnership, often with board involvement and full upside and downside exposure.
Many equity investors are comfortable with debt, but they may be sensitive to certain liens or pledges or to specific lenders names. Both lenders and investors generally prefer that funds are used for growth, not to refinance existing debt.
Because shareholders may have different views on debt and various debt structures and providers exist, it could be wise to include a flexible early repayment clause in your debt agreement. This provides you with flexibility to replace debt with new funding, if needed, at a reasonable cost.
Is board approval required for a venture debt transaction?
Yes, most tech companies’ Articles of Association require board approval for financings above a certain amount or that impose liens or other restrictions on the company or its assets.
Since many board members may have limited experience with non-dilutive financing options, it’s recommended to present multiple offers so they can compare alternatives. Offers can differ significantly, for example, a cohort financing versus a bridge term loan. In such cases, it helps to provide a financial model showing monthly cash-flow impact or a financial expert opinion outlining the pros and cons of each option.
What are the downsides of venture debt?
Debt must be repaid, which requires careful cash-flow management and accurate financial forecasting to ensure sufficient liquidity at all times.
Lenders often take security interests (such as liens on bank accounts or company assets) and impose covenants that give them some control over certain business decisions, like dividend distributions, business changes, or taking on additional debt.
Venture debt works best for growing businesses with positive cash flow, but it can become challenging if growth slows or the business contracts.