Boards and Venture Debt

How to secure a pre-agreed Venture debt financing in front of your Board of Directors. Less is more.

Author: Lucas de la Vega for Medium.

As a Venture debt investor, I’ve faced an important number of awkward situations in Board Meetings (as an observer! –as you may remember Venture debt does not have any voting rights-). During Boards time is a scarce resource, and you rather stick the discussion to the business.

Unfortunately, Venture debt is rather a complex form of financing which includes a tailored interest, amortization and equity remuneration (see Venture Debt 101). Not to mention, the headache of trying to compare different Venture debt Term Sheets.

  • How to present a potential Venture debt Term Sheet in front of your board?

Simplify the terms and conditions of the loan. People often get stuck in non-critical aspects of the financing, try to show-up the big picture.

A typical Venture Debt Term Sheet could include: (i) Multiple tranches, (ii) a dynamic valuation (i.e. discount to round, time-weighted average) and (iii) Covenants & Collateral implications.

There are hundreds of possible scenarios, choose a base case to present to your board and be concise about the agreed terms and conditions.

Facts and figures of the items in the loan should be at the top of your one-pager
Facts and figures of the items in the loan should be at the top of your one-pager

Valuation is always an issue. Venture debt is much less dilutive than equity. Be sure that everybody on the table understands the Equity capital savings.

From the example above – €2m ticket at €8m Eq. Value would imply a 20% dilution (€2m÷(€8m+€2m) with Equity Capital and only 6% with the use of Venture debt (€2m x 25%= 500k ; €500k÷€8m= 6%)

Venture debt is an alternative to Venture Capital, not Banks
Venture debt is an alternative to Venture Capital, not Banks

Bear in mind that Venture debt is unknown to most people, your Board members are no exception. At some point, someone will play the wise guy and benchmark Venture debt with Bank financing (here is quick answer!).

As a reminder Venture debt should be a replacement to Equity and not Bank debt.

Lenders may protect themselves with clauses. You should be well acquainted with the implications of the Covenants and Collateral.

As an example, Maximum debt capacity could potentially limit the cash inflows from public funds (i.e. H2020) increasing the blended cost of financing. Pledge on shares could jeopardize a hypothetical refinancing opportunity.

Restrictive covenants could potentially be translated into higher costs
Restrictive covenants could potentially be translated into higher costs

Focus on opportunities and risks

Onboarding a Venture debt lender is an important milestone, you should back your speech with major reasons. Be crystal clear about the extended runway of the proposed Venture Debt and the expected increase in Valuation given the dilution (vs. Equity Capital).

Breakdown of Proceeds — VC vs. VD
Breakdown of Proceeds — VC vs. VD

Concerning the risks, you should try to determine how bad may you perform in order to miss your repayment obligations (i.e. missing the sales target, churn increase, working capital delay).You should be able to track the performance of these metrics on a monthly basis.

People don’t like what they don’t understand, make it easier for everybody with charts and monthly economics.

1. The monthly debt burden (principal and interests which will show all monthly installments). Remember your operating Cash Flow should be at least 2x-4x your debt burden in the long run.

From the facility presented above-Maximum monthly installments of €75k
From the facility presented above-Maximum monthly installments of €75k

2. The cash profile of the facility (which will help you to see the peak funding of your facility). Tranching is used to reduce interest payments on the unused amounts, it is also helpful to reduce refinancing risk.

Repayment will depend on the number of tranches, grace period and maturity
Repayment will depend on the number of tranches, grace period and maturity

I strongly recommend to having an open discussion with you Venture debt lender in order to adjust the facility to your company needs.

Venture debt providers will help you structure the deal
Venture debt providers will help you structure the deal

You find a template here to draft a your own tailor made proposal.

Once you’ve crunched the numbers and the Board is at ease with the proposal it is time to discuss about the key advantages of Venture debt.

Find below the not so obvious advantages of a Venture debt beyond the economic benefit.

1. Venture debt has no political rights

Probably the most important reason why you should onboard a Venture debt provider is to release some pressure from the Exit. Venture debt investor holds no political rights and therefore you will be able to sell you company whenever you want.

Following Point Nine Capital SaaS Napkin scheme, you’ve been able to raise €2m at a Seed round at €6m (Post Money). Two years later you still need €5m ticket to grow fast and you are planning a Series A at a €20m.

Management stake would be reduced to 50% during the early-stage rounds
Management stake would be reduced to 50% during the early-stage rounds

Expected exit of a Venture Capital fund if a company that has proven traction should be 5–10x their investment. In case you and your shareholders would receive a full-cash offer from a third party of €40m (Eur. Average B2B SaaS Exit 2019) the latest investor could potentially block the sale as he did not achieve his minimum return expectations.

Time to exit is also relevant, founders who started operations one year before seed round could have a substantial exit at the fifth year, while onboarding a new equity provider might extend the Exit for at least three to five years more.

2. Lower dilution, maintain control over your company

Investors expectations are not always aligned with management
Investors expectations are not always aligned with management

You already know the dilution savings that Venture debt offers. The fact of bridging a round may help founders to maintain a majority stake in the company (see example above, founders lost their majority stake).

For professional investors, onboarding a Venture debt may help to retain weight in the company important decisions.

3. Quick capital call used as a safety net

A good half of the art running a company is resilience
A good half of the art running a company is resilience

Venture debt could be used as a security buffer on the bumpy road to success. Small companies are flexible but in exchange they are sensitive to headwinds.

Optionality is priceless in volatile environments, Venture debt may invest relevant amounts of money in a swift.

4. Financing Special Situations

Venture debt could be a great tool to seize relevant opportunities to build-up your company and could help to finance some Corporate transactions at a much lower cost than Equity capital.

Venture debt funds are generally happy to provide debt to medium and small Tech companies for inorganic growth (M&A, Acquisitions, Add-ons) this could obviously lead to arbitrage and capital gains. In addition, they are also flexible enough to advance payments from relevant corporate purposes (Spin-off, important one-shot payments).

5. Strong signaling towards a Venture Capital round or Exit

VC and VD, same dog, different collar
VC and VD, same dog, different collar

Venture Capital and Venture debt are both birds of the same feather. Relationship among these two is generally very close given the co-investor nature of the second.

In addition, Venture debt deals are meant to have a low-risk profile for a Venture Capital that would be willing to balance its portfolio risk-reward strategy.

From an Exit perspective, Venture debt is often seen as the last step before breakeven. Once you’ve become (or ought to become) a Cash Flow Positive company you will be eligible for a whole new spectrum of buyers.

In both cases, rounding or exit, Venture debt is a great ally. Negotiating with a bulk of money in your account will change the status-quo and the final terms of the deal.

Fortune favors the bold, closing a Venture debt agreement will be tough you will need to align both your current shareholders and the Venture debt provider. Try to involve everybody from the start so that everybody moves in the same direction.


Zubi Capital Asset Management lanza el primer fondo de venture capital de impacto en diversidad e inclusión en España

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