What is Venture Debt and How Does it Work? [2025]

Traditional venture debt raised $56.5 billion in 2023, showing how it’s a complementary form of financing to equity. While venture debt funding can be a good choice for some startups, it’s crucial to understand how it might fit into your business.

Unlike conventional startup loans, venture debt can be personalized to the unique needs and risk profiles of high-growth companies. In this article, we’ll explore the intricacies of venture debt, its uses, and when it’s most appropriate for startups.

Plus, we’ll also include some alternative financing methods in case venture debt isn’t what fits your startup best.

What is Venture Debt?

Venture debt is a specialized form of debt financing designed for venture-backed startups and growth-stage companies. It typically comes in the form of a term loan or revolving credit line, offered by specialized lenders or banks familiar with the startup ecosystem.

Unlike traditional bank loans, venture debt doesn’t require hard assets as collateral but often includes warrants for company stock. This debt is usually senior to equity but subordinate to other debt, with repayment terms typically ranging from 24 to 48 months.

However, venture debt comes with its own set of challenges. For instance, it often requires regular repayments regardless of company performance, which can constrain cash flow. The inclusion of warrants leads to some equity dilution, and the debt may come with restrictions.

What is Venture Debt Used For?

Venture debt primarily extends a company’s runway, providing additional capital to reach key milestones before the next equity round. This form of financing can fund specific projects, such as equipment purchases, expansions, or acquisitions.

It’s often used as bridge financing between equity rounds, offering capital to sustain operations until the next funding event. Venture debt allows companies to reduce equity dilution by raising capital without issuing additional shares.

It can also serve as working capital, supporting day-to-day operations and growth initiatives. In some cases, it’s used for debt refinancing, replacing existing debt with more favorable terms.

Venture Debt vs Conventional Debt

Unlike conventional loans, venture debt rarely requires hard assets as collateral. Venture lenders accept higher risk, focusing on growth potential rather than current profitability. However, that typically means there’s a higher risk-to-reward ratio when comparing venture and conventional debt.

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Venture debt also includes stock warrants, giving lenders potential equity upside. However, interest rates for venture debt are generally higher than conventional debt because of the risk. Lastly, venture debt is tailored for hyper-specific businesses rather than any ordinary business, reflecting a specialized borrower profile when compared to conventional debt.

Venture Debt Example

Let’s say a SaaS startup raises a $10 million Series A at a $40 million valuation. They secure $3 million in venture debt with the following terms:

• 36-month term loan
• 15% annual interest rate
• 6-month interest-only period
• Warrants for 1% of the company’s equity

The venture debt extends the startup’s runway by nine months, allowing them to hit key growth metrics before their Series B.

At their Series B, they raise at a $200 million valuation. If they had raised that $3 million via equity - at the prior $40 million valuation - that percentage ownership would represent a significant financial value at the new Series B valuation (excluding any impact of dilution).

The total cost of capital (including warrant dilution) is much lower using venture debt, than raising an additional $3 million in equity.

However, in the case the startup fails to meet its growth targets and does not raise a Series B, the debt payments could become a significant burden. In a worse-case scenario, the company could default on its debt, leading to bankruptcy.

How Does Venture Debt Work?

Venture debt includes several steps:

1. Qualification: Company secures venture capital funding, typically Series A or later.

2. Application: Startup approaches venture debt lenders with business plan and financials.

3. Due diligence: Lender evaluates company’s growth potential, market, and VC backers.

4. Term sheet: Lender offers terms including loan amount, interest rate, and warrants.

5. Negotiation: Company and lender finalize terms.

6. Closing: Legal documentation is signed, and funds are disbursed.

7. Repayment: Company makes interest and principal payments over the loan term.

8. Warrant exercise: Lender may exercise warrants for equity stake.

When you should raise venture debt

Here are some scenarios where you might consider raising venture debt:

• After raising a significant equity round with 12-18 months of runway remaining
• When approaching profitability but needing extra capital to cross the finish line
• To fund specific growth initiatives with clear return on investment
• When anticipating a future equity round but wanting to extend runway
• To finance acquisitions or major equipment purchases
• When the cost of debt is lower than the implied cost of equity dilution

When you shouldn’t raise venture debt

However, there are definitely some times when you shouldn’t raise venture debt. Consider another financing option if:

• You lack a clear path to profitability or next equity round
• Cash flow is insufficient to service debt payments
• The terms offered are overly onerous or restrictive
• Your company is in pre-revenue or very early stage
• There’s a significant market or regulatory uncertainty
• Existing investors are unwilling to support the debt raise
• The debt would overly complicate the capital structure for future rounds

Types of Venture Debt

Venture debt comes in several forms, each tailored to different company needs and stages. Here are the main types:

1. Business Line of Credit

A business line of credit is a revolving credit facility that allows companies to draw and repay funds as needed. Interest is typically only paid on the amount drawn, making it cost-effective for variable capital needs

2. Convertible Debt

This type of venture debt can convert into equity under certain conditions, usually at a discount to the next equity round. It combines features of debt and equity, offering lenders potential upside while providing companies with more favorable terms than straight debt.

3. Growth Capital Term Debt

Growth capital term debt is a traditional term loan structure, often used for specific growth initiatives or to extend runway. It typically has a fixed repayment schedule and may include an interest-only period at the beginning of the term.

Venture Debt Advantages and Disadvantages

Understanding the pros and cons of venture debt is crucial for startups considering this financing option:

Benefits of Venture Debt

Here are a few benefits to venture debt:

• Less dilutive than equity financing
• Extends runway without immediate equity dilution
• Possibly lower cost of capital compared to equity
• Flexible use of funds
• Can complement and strengthen equity rounds
• Potentially improves terms of future equity raises

Venture Debt Limitations

However, venture debt also has some implications:

• Requires regular repayments, impacting cash flow
• Higher interest rates than traditional bank loans
• Often requires equity kicker (warrants), leading to some dilution
• May include restrictive covenants
• Typically only available to VC-backed companies
• Can be risky if company underperforms
• May complicate future funding rounds

Best Alternatives to Venture Debt: Quick Overview

If you don’t think venture debt is right for you, here’s a quick breakdown of some of the best alternatives to venture debt:

Best Alternatives to Venture Debt: Complete Review

While venture debt is the choice many startups make, it might not always be the optimal choice in every case. Here’s a look at some of the alternatives:

1. Revenue-based Financing

Revenue-based financing (RBF) is a type of funding you receive based on your revenue, repaid in monthly installments. It typically requires a fixed fee amount of money (10-14%) on top of the financing you receive that is to be repaid over a designated period.

Efficient Capital Labs (ECL) provides the premier RBF solution for SaaS companies, offering up to $2 million in non-dilutive capital with a straightforward fee structure of 10-14% for USD funding.

ECL’s model allows for rapid funding within 72 hours, requires no warrants or collateral, and provides the flexibility to use funds as needed.

Pros:

• Non-dilutive
• Retain ownership and full company control
• Fixed, flat fees of 10-14%
• No warrants or collateral required
• Faster approval process than traditional loans

Cons:

• Not suitable for pre-revenue companies
• Funding amount is limited by your annual revenue

Venture Debt vs Revenue-based Financing

While venture debt often requires equity backing and could work for larger, later-stage startups, revenue-based financing offers a flexible alternative for earlier-stage companies with consistent revenue. Venture debt is also more difficult to access, given that it requires a longer time frame to raise and go through review processes with debt providers.

With venture debt you may be able to access longer terms for repayment, with a structure more similar to a typical bank loan.

Revenue-based financing allows you to keep full control of your company, get quick access to capital, and fix any cash flow problems your company has with flat-rate financing. Instead of giving up more control and equity, you can get profitable first and prepare yourself for future rounds.

Ready to explore how revenue-based financing can accelerate your startup’s growth? Apply now with ECL and get funded in as little as 3 days.

2. Bank Debt

Traditional bank debt involves borrowing money from a bank, typically with fixed interest rates and repayment terms. It's generally less expensive than venture debt but often requires collateral or personal guarantees.

Pros:

• Lower interest rates
• No equity dilution
• Potential for larger loan amounts

Cons:

• Strict qualification criteria
• Often requires collateral or personal guarantees
• Less flexible terms than venture debt

Venture Debt vs Bank Debt

Venture debt is typically more accessible and flexible for startups compared to bank debt, but comes at a higher cost and potential to lose ownership via equity warrants. While bank debt offers lower interest rates, it often requires profitability, significant assets, or loan collateral that many startups can’t provide. Venture debt, on the other hand, focuses more on a company’s growth potential and VC backing.

3. Equity

Equity financing involves selling a portion of ownership in your company in exchange for capital. This can come from venture capitalists, angel investors, or through public offerings. It also typically requires a proof of concept, market validation, and a compelling vision.

Pros:

• No monetary repayment required
• Provides strategic partners and expertise
• Potential for larger funding amounts

Cons:

• Dilutes ownership
• Loss of some control over the company
• Can be a lengthy and complex process

Venture Debt vs Equity

Venture debt offers a way to extend runway without immediate equity dilution, making it an attractive complement to equity financing. While equity can provide larger amounts of capital and strategic partnerships, it comes at the cost of ownership dilution.

Venture debt allows companies to leverage their equity funding while potentially improving terms for future equity rounds.

More About Venture Debt

As you consider venture debt, you may have additional questions. Here are answers to some common inquiries:

Is venture debt a good idea?

Venture debt can be a good idea for companies that have strong growth prospects, a clear path to their next equity round or profitability, and the ability to make regular debt payments. It’s particularly useful for extending runway, funding specific growth initiatives, or reducing dilution.

However, it’s not suitable for all startups and should be carefully considered based on your company’s specific situation and goals. For example, a startup with monthly recurring revenue might find RBF a less risky, more affordable option for funding growth. That way, you can avoid the potential pitfalls of equity dilution and debt payments.

What happens if you can’t repay venture debt?

If a company can’t repay venture debt, the consequences can be severe. The lender may have the right to seize assets, enforce warrants (potentially taking a significant equity stake), or push the company into bankruptcy.

How to negotiate venture debt

When negotiating venture debt, focus on key terms such as interest rate, repayment schedule, covenants, and warrants. Seek multiple term sheets to compare offers. Leverage your VC relationships and company growth prospects to secure better terms.

Additionally, be prepared to discuss your financial projections, use of funds, and path to the next equity round or profitability. Consider hiring a lawyer experienced in venture debt to review and negotiate terms.

Should You Use Venture Debt For Your Business?

While venture debt can be effective for extending runway or funding growth initiatives, it’s not suitable for every startup. If you have MRR and six months of revenue history, you are eligible to consider alternative financing options.

For many startups, especially those in earlier stages or with consistent revenue streams, revenue-based finance could be a more suitable alternative.

Revenue-based finance is non-dilutive funding, which enables faster access to funds without requiring VC backing or giving up any ownership. ECL provides a best-in-class RBF solution, offering up to $2.5 million in growth capital within three days, without equity dilution or collateral.

If you’re seeking funding that aligns with your growth trajectory without the complexities of venture debt, explore ECL’s revenue-based financing.