Negotiating corporate debt term sheets for your climate business

Corporate debt can be a powerful tool in building your climate startup, providing much-needed working capital without giving up ownership of your business. One of the most important steps with any type of corporate debt transaction  — including venture debt, equipment financing, or receivable financing  — is the negotiation of a term sheet, where you and the lender define the commercial parameters of the loan. This stage of investment gives you the opportunity to push back on some of the terms  — but first, you must understand them.

David Lynn is CEO of Mission Driven Finance®. We sat down with him to discuss what’s most likely to appear on a term sheet, tips for the negotiation process, and the pitfalls you should watch out for.

The most common terms on a term sheet

Loan amount 
There’s the total dollar value of the loan, then there’s the loan value available to your business. The loan may come in a lump sum, in phases (AKA “tranches”), or as a line of credit, and may have requirements like minimum draw amounts. Make sure the amount and timeline fit your business needs.

Interest rate 
This can be fixed or floating. If the latter, it will often be tied to a federal rate like SOFR or the prime rate (easily found online). Make sure you pay attention to how the interest is charged. Is it on a declining principal balance or is it “simple interest”? Does it compound? All of these questions will affect your cost of financing and are important to include in your financial projections.

Maturity and payment schedule 
So when do you owe payments on the loan? A loan might have interest-only payments for some fixed time period, may fully amortize from the start (i.e. paying principal plus interest), or something in between. This section will also note whether there are any step-ups where payments will increase, and any event-driven payment requirements to look out for.

Fees
These can include origination fees, servicing fees, closing fees, payment fees, prepayment fees, legal fees, and more. Many lenders will hide their cost of capital in fees, so pay careful attention to this section. Also make sure to understand if your funding amount will have fees netted out, if some fees need to be paid prior to closing, etc.

Security (Collateral)
The term sheet will specify which assets are used as security (collateral) for the loan. The lender could take an all-assets lien, or just security on your receivables. It may also specify if a guarantor (third party, parent company, or personal) is required. Keep in mind that any personal guarantees you take on for a loan mean you are personally responsible for repaying the loan even if your business cannot.

Covenants
These are conditions you must meet during the life of the loan, such as maintaining a certain amount of liquidity or meeting a specific debt service coverage ratio over the life of the loan, along with how often this will be tested. They may also prevent you from taking on other financing without the lender’s approval. Some covenants, like maintaining good standing in your state of domicile, are almost universal. Others are not. Make sure you understand the implications of each covenant.

Warrants and other equity-related provisions
Often seen in venture debt and other private (non-bank) credit transactions, warrants give the lender the right to purchase your company's stock at a specific price for a period of time following investment. A conversion clause (convertible debt) might also be included, specifying who can choose to convert the corporate debt to equity These terms can affect—and should be included on—your cap table.

Seniority
Most loans from banks and large financial institutions are senior, meaning they are repaid first in the event of delinquency, default, or bankruptcy, and generally have priority over other lenders to collect their payment day to day. If you plan on taking debt from multiple parties, make sure their seniority interests are compatible or they might need an intercreditor agreement.

Reporting requirements
The lender might ask for financial information on a monthly, quarterly, or annual basis, potentially with auditing requirements. Impact reporting might also be requested by certain lenders. You’ll also need to remain in good standing with your state reporting agencies and file taxes on time.

Exclusivity clause 
Lenders often want exclusivity during their due diligence period (typically 60-90 days after you sign the term sheet), meaning you can't pursue other loan offers during this time

How different terms relate to each other

It’s important to understand that the terms on your term sheet are all interconnected, and if you push for a change in one area, something else generally has to shift to compensate. From the lender’s perspective, the deal needs to balance risk and return, so if you negotiate down to a lower rate, they’ll typically require an increase in security or collateral, a shorter loan period, or a guarantee. 

On the other hand, if you want to reduce their safety — say, you don’t want to use your IP as collateral — this will usually incur an increase in fees, interest rate, or warrants. 

It’s important you recognize this going in, and avoid prioritizing a better interest rate while overlooking the other terms, or you could end up paying a far harsher price down the road.

How to get the best offer on your term sheet

Know what you need
The lender will look at how you intend to use the funds, and how you’ll repay the loan. Consider if debt—with regular monthly payments—truly fits your needs, or if a different structure—like a line of credit, bridge loan, revenue-based financing, or equity—might be more appropriate. Do you have a specific, time-bound need, like an essential piece of equipment or inventory? Do you have a specific revenue event that will enable you to repay the lender in a lump sum? Or do you have clear, ongoing cash flow that will cover your debt service (both interest and principal) month to month? 

Once this is clear, you can steer the conversation towards terms that align with what your business can deliver — at which point, the interest rate may become far less relevant. Knowing what you want — and need — will also help you avoid a lot of headaches. If you’ve built a financial model and figured out you can pay an interest rate of up to 15%, you’ll know what you can afford and can eliminate a lot of lenders off the bat.

Understand what your lender can do
Before seeing the term sheet, ask the lender what terms are typically included, and where they have flexibility. Is the interest a range, or do they have a specified credit model that defines the price? If there isn’t much room for negotiation in the rate or terms, what about the covenants?

Study the finer points
The more you understand how debt works, the better equipped you’ll be when it comes to negotiating. For example, if you’re borrowing against a contract and have more receivables than the lender is lending against, you may be able to negotiate a more patient payment schedule, freeing up funds for your business to use in the short term. But to pull this off, you need to grasp the nuances of the type of debt you’re raising. So, do your homework as much as possible: Research the typical term loan amortization structures and the different ways your lender structures the loans. 

To learn more about different types of debt, check out Enduring Planet’s Insights on equipment financing, and how Mission Driven Finance breaks down amortization.

Pause, then ask 
Once you have the term sheet in your hands, ask for some time. You can stall by saying you need to talk to your board — whether that’s true or not — or negotiate to extend the time period the term sheet is valid for. 

Use that time to talk to your advisors and other people who understand debt (that may or may not include VCs) to figure out what your “need-to-have” and “nice-to-have” terms are. Once you have a handle on things, be direct and ask the lender for everything you want—even things that are sure to be rejected. This creates a dynamic where they might feel more obligated to approve at least some of your requests.

This comes with the caveat, however, that as an early-stage startup, you don’t have a lot of pricing power. Make sure you understand what the market looks like for small, unprofitable businesses, and know when you’re actually getting a good deal — and what for you is non-negotiable.

Avoiding common mistakes 

Think long-term
If you’re taking on a loan to solve today’s problem without considering how it fits into your long-term fundraising strategy, you’re jeopardizing your future capital stack. Having a loan on your books carries a lot of downstream effects  — and if you don’t pay attention, it can be as damaging as mismanaging your cap table, making your next financing incredibly tough. 

Don’t overlook your other lenders
Make sure you understand all the rights any lender in your stack has, and whether you have permission to take on new debt. Run your own UCC check and re-read any existing loan agreements first to avoid surprises. If one of your current lenders is unhappy about new financing, they could accelerate their loan or put you in default for breaking a covenant.

Prepare your data room
Don't try to raise debt without first creating a comprehensive data room that includes all your financials, models, and contracts. Not having this prepared will slow things down tremendously — and for some lenders — can be a huge red flag.

Know what you’re getting into
Remember that lenders have significant control over your company. As long as you're making payments on time, your lenders might never bother you again. While minority shareholders can cause issues, a lender has the power to take your company if you default. 

By understanding these terms and negotiation strategies, climate entrepreneurs can navigate the corporate debt landscape more effectively.

David Lynn co-founded Mission Driven Finance®️ in 2016 after spending 20 years working in the financial and philanthropic sectors looking for a way to blend those two worlds. He and Co-founder Lauren Grattan started the impact asset management firm with the goal of building a financial system that ensures good businesses have access to sufficient, affordable capital. Mission Driven Finance works with local and national investors to help them create the impact they want and work with businesses and community partners to help them get the capital they need. Prior to focusing on impact investing, David specialized in family office investment portfolios including both private investments and risk management through derivatives. With a long dedication to community involvement, David has served in a leadership capacity for a variety of nonprofit and philanthropic initiatives, including San Diego Grantmakers, San Diego Impact Investors Network, Education Synergy Alliance, Mission Edge San Diego, San Diego Social Venture Partners, and San Diego Humane Society.