Venture debt is a form of non-dilutive capital that is designed specifically for venture capital-backed technology and life science companies. These companies typically do not have the cash flow or assets to use as collateral for traditional debt financing, and thus use venture debt to fund working capital, operating expenses, and various other growth initiatives. Venture debt is designed to be less restrictive and far more customizable than traditional bank debt, but with that flexibility comes a higher cost of capital.

I connected with Eddie Lopez, Vice President at Hercules Capital, to dive deeper into venture debt.

When should startups consider venture debt?

EL: A startup should always consider venture debt as a financing vehicle to increase technical/business model validation and enterprise value growth. That said, its scale, the time in which it is considering raising, and the use case for the capital can impact the terms and structure of a potential venture debt facility.

For early-stage companies with minimal operating history, venture debt facilities are smaller and typically most appropriate after an equity raise, as lenders will underwrite to the quality of the investors and their recent support in the business.

Growth- and late-stage companies with more commercial traction have more flexibility in the timing of raising venture debt as lenders will prioritize the scale and fundamentals of the business over any previous or future equity support. These facilities are larger and serve a more strategic use case beyond extending cash runway.

What can venture debt be used for?

EL: Venture debt covers the entire spectrum of strategic debt financing, including cash runway extension, working capital support, purchasing equipment, and acquisition financing. As is the case with raising equity, management should consult with its board to ensure the type of debt financing and structure it is looking for aligns with the company’s capital strategy.

Who is eligible?

EL: Venture debt has traditionally catered to sponsor-backed technology and life science startups that prioritize growth over profitability. Over the years, several venture debt providers have emerged to address the debt needs of startups at various stages (from Series A to Pre-IPO), and as mentioned previously, the structural configurations of a facility can vary depending on the existing commercial traction of the business.

What is the process for receiving venture debt?

EL: Typically, after the initial introductory call, a venture debt lender will ask for a list of diligence materials, which includes, among other things, a company overview presentation, a detailed capitalization table highlighting a company’s fundraising history, and historical/projected financials. These materials, along with a follow-up discussion with management to address any diligence questions, should be enough information to help a venture debt lender not only qualify a potential debt investment but what that debt would look like. Timelines can vary depending on the size of the transaction and use case.

What is the fee structure like? What is the cost of capital? How should startups think about pricing? What are the additional terms that are noteworthy?

EL: The cost of capital for venture debt varies amongst lenders. Traditional commercial banks can offer venture debt at a lower cost of capital (in exchange for mandating the company’s banking business) but is more restrictive (lower commitment amount, financial covenants, depository requirements, etc.). Venture debt from a non-bank provider comes at a higher cost but can offer more flexibility, i.e. large debt facility with longer commitment periods and little to no financial covenants.
Beyond the cost of capital, it is important for startups, before signing off on a debt facility, to confirm the amount of capital that is being made available to them and when. It is common for venture debt providers (both bank and non-bank) to tranche their commitment and, in certain instances, make it available only upon achievement of certain performance milestones or lender approval. While tranching the commitment can help reduce upfront costs (paying only for what you have available on Day 1), it could potentially hinder a startup from accessing the remaining amount if the agreed-upon milestones cannot be achieved.