Venture Term Loans

Thanks for joining another week of INTRO to Finance. I'm Jason, and each week we explore finance topics that can help you on your entrepreneurial journey. This week we will be answering this question:

"What is a Venture Term Loan?"

Many times this kind of financing is broadly described as Venture Debt because it is provided to startups. However, a Venture Term Loan is a specific type of financing and is a significant part of the Venture Capital industry.

How it Works

Venture Term Loans are provided to companies that have already received an equity investment from a Venture Capital firm. Typically, when a VC invests in your company, they reserve some capital to continue to invest in the company at a later date. The reserved money might be used in the next capital raise that the company has or used to support the company with more capital if it is struggling.

For lenders, the reserves provide comfort that your VCs have the capital to provide if the company struggles and can help pay back the loan. 

Even with the reserves acting as a backstop, lenders still build in some cushion, which is why Venture Term Loans are not the same size as your equity raise. In most cases, these loans are 30-50% of the round of funding.

How is it Structured?

The best part about this type of debt capital is that it is very flexible to use. In most cases, there are no covenants or restrictions on how you use the money. The capital can feel like an increase in the round of equity that you just raised. 

However, you still do have to pay back the capital over a stated time. Typically, companies must make equal monthly payments over 3 to 4 years until the loan is repaid. 

Because the capital is flexible to use like equity, most lenders will ask for some equity compensation, which is why this is not a non-dilutive capital source. It is frequently referred to as a minimally dilutive capital source because the total dilution to your company for this type of capital doesn't typically exceed 1% of the company.

Why It May Make Sense

Most companies find low equity costs and flexible-use as the primary driver of using Venture Term Loans. As an example, a company may raise a $3M round of funding for 15% dilution. A Venture Term Loan could allow the company to increase the cash raise by another $1M. The dilution cost would be a maximum of 1% instead of another 5% dilution if raised in equity. All while still having the same amount of flexibility that equity provides.

For these reasons, most companies that raise VC also raise a Venture Term Loan. However, it’s not available forever. Lenders want to provide the capital as close to the round of equity as possible to make sure you still have a healthy amount of cash to service the debt. Some companies will raise the equity and Venture Term Loans simultaneously, but you should start conversations with lenders within three months of raising your equity rounds. 

If you’re looking to start conversations, build your INTRO profile to see if you are a fit.

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