Understanding venture debt for climate tech

Venture debt allows you to grow your climate startup without the same dilutive impact as raising additional equity, e.g. venture capital. Usually offered to companies who’ve recently raised a significant round of VC funding, this non-dilutive source of funding can either help you accelerate to the next milestone, or simply act as an insurance policy to help ensure you have enough runway to get to the next round. Getting up to speed with this type of loan is vital for any founder - especially in today’s challenging economic environment.

Jane Ullman is a Managing Director at Silicon Valley Bank leading their Portland office, and has ​​spent most of her career as a CFO for tech startups and social enterprises. We sat down with her to discuss why venture debt is a great complement to equity for early-stage founders, when to initiate conversations with lenders, and key terms to look out for.

When and why you should go for venture debt

Venture debt is a term loan that’s usually available to companies who’ve recently raised a minimum of $4m from VCs. If you’ve just closed a round, you’ve got good product-market fit, and you know you could rapidly accelerate revenue growth with additional capital, you should consider venture debt. Alternatively, sometimes venture debt helps a company through difficult times if things aren’t going as expected, or through a period of economic downturn. The intent of venture debt is to extend your runway until you can raise the next round of equity.

Keep in mind that there’s usually a narrow window of time in which you can raise venture debt, because you’ll need money in the bank - and the more you have, the better the terms will be. So it’s best to start speaking to potential lenders before your round closes, and move the process forward shortly after it does. You might not need the money immediately, and the loan’s drawdown period will allow you to postpone the date you start using it, either in full or in part.

Deciphering the venture debt term sheet

Types of lenders
The lowest cost source of venture debt for early-stage companies is usually banks. There are also private debt funds that provide venture debt. Generally, these will be more expensive, with a higher interest rate and larger allocation of warrants, but they still may be a good match for your business. There are also other lenders that tend to come into the picture when a company is not a fit for venture debt from banks and mainstream funds. These often come with a much higher cost and more restrictive terms.

Drawdown and Repayment
Commonly, venture debt will carry a term of three to four years with an interest only period around one year, followed by the remaining years of principal plus interest, in consistent monthly payments.  Some lenders may offer creative amortization schedules that allow for lower repayment in the early years, or other variations.

Venture debt usually includes a draw period, i.e. you won’t have to take all the capital at once, but can “draw” on the facility throughout the draw period.  While the draw period is separate from the interest-only period, they often run simultaneously, for example, - a draw period of 12 months from the day you close the loan, and a 12 month interest-only period starting the same day are common.

Interest
Interest rates for venture debt vary by lender and by company but are generally pegged to the Prime rate.  For banks, the interest rate is generally prime plus 1% or less, and this is in all likelihood the lowest interest rate you’ll find on debt as an early-stage company. Venture debt funds and alternative credit providers will generally have higher rates, but fewer strings attached on some other terms such as where you maintain operating accounts and other services.

Warrants
Venture debt providers will also take a small amount of warrants. The exact values will depend on the lender and company, but for most banks, these will be at less than half of a percent.  While this may seem immaterial, the value of these warrants can dramatically balloon if you’re successful, so it’s important to consider their effective cost when weighing diverse venture debt options.

Size of the loan
The dollar amount of the venture debt facility will generally be 20-30% of the size of your round or 6-8% of your last post-money valuation. If your cash balance has decreased substantially because you waited too long after your raise to approach a lender, it will likely be difficult to raise venture debt and/or the size of the loan will be substantially smaller.

Security
Venture lenders are generally senior secured lenders, which means they take a lien on all of the company's assets (generally with the exception of IP). However, you may have to sign a negative IP covenant, i.e. that you won’t be allowed to pledge your IP to anyone else for another loan or investment. 

Fees
You’ll often have to pay an origination fee upfront, which varies by lender, the size of the facility, and other factors. You’ll also be responsible for your legal fees and the bank’s legal fees - but some lenders have developed streamlined lending practices, so these fees may be waived or de minimis. These fees can range from $5K to $50K depending on the size and complexity of the transaction, the amount of negotiation, and the scope of legal revisions that a company may seek throughout the process.

Other considerations
Industry practices have shifted a bit since the most recent banking crisis, so it’s no longer a requirement that you do 100% of your banking with your venture debt lender (if they’re a bank), but some will insist on a certain percentage or components - ask upfront what they require of you. 

What founders considering venture debt should know

1. It might take longer than you think
Since you’ll have all of the documentation and due diligence on hand from your fundraising round, applying for venture debt is relatively straightforward. But if it’s your first time, it’ll take a bit longer to learn the ropes.

Once you’ve sent the lender the documentation, the ball is in their court. In a streamlined process, it’ll usually take a week or two to produce a term sheet, a week or two of negotiation around the commercial terms, and another week or two on top of that to get the documents reviewed and signed. The total, in a streamlined case, can be as short as a few weeks.

In non-streamlined cases – more complex situations or where you spend a lot of time negotiating legal terms, etc. - you can expect it to take another month (or more) to close. There may also be more diligence required after the term sheet, depending on the quality of the initial materials.

2. Lenders will reach out to your investors
Rather than duplicating your investors’ work, venture debt lenders will piggyback on the due diligence conducted by your lead investor. This means they’ll want to get their perspective, as well find out whether they’re committed to repeating their investment, how much of their fund remains, and whether they hold reserves for your company - essentially, they’ll be looking for assurance that your business will continue to get their support, through thick or thin.

If your lender has a history with your VC and knows how they’re likely to behave, they’ll feel more comfortable with them - and by extension, more confident in giving you the loan. So if you’re considering venture debt, talk to your prospective lead investor and ask if they have any relationships with lenders who you can then engage. At the very least, ask for their opinion on venture debt, as not all VCs are supportive.

3. Think hard before negotiating
It’s always worth pushing for a better deal on the commercial terms, but negotiating with a lender on boilerplate legal terms is most likely going to be a waste of your time and money - which are much better served moving your business forward. 

Jane has more than 30 years’ experience in finance, investment banking, and commercial banking.  She currently leads Silicon Valley Bank’s practice in Oregon. Jane has been the CFO of multiple VC-backed technology startups in SaaS, ecommerce, and healthcare. She has also worked extensively with startups and social enterprises in Africa, as a CFO for a mobile technology company in West Africa and as an investment banker in East Africa with the World Bank. She started her career as an engineer designing solar energy systems. She holds an MBA from Stanford and a BA in mechanical engineering/math/geology from Vanderbilt.