Venture Debt
Also known as: Growth debt, Venture lending
Lending to companies that lose money, secured on the expectation that someone else will fund them again. Cheaper than equity for the founder, and a bet on the next round for the lender.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A venture-backed company burning cash needs money. Selling more equity dilutes the founders and the existing investors. Venture debt offers a third path: borrow now, repay from the next equity round.
Conventional credit analysis does not apply. The borrower has no profits, often little revenue, and few assets worth repossessing. The lender is underwriting something else entirely:
- The quality of the equity investors behind it. A company backed by well-capitalised funds is far more likely to be funded again.
- The cash runway. Does the loan take the company to a milestone that makes the next round achievable?
- The warrants. The lender takes a small equity option alongside the loan — the upside that compensates for a loss rate no interest coupon could cover.
a paymentsomething deliveredonly if a condition is met
The lender knows the borrower may not survive, so it is paid in two currencies: interest, and an option on the equity.
At the drawdown
- The lender → The startup Advanced only because venture capital has just gone in. The lender is really underwriting the last round's investors and their willingness to fund again.
- The startup → The lender A small equity option, granted at the outset. It costs the founders dilution rather than cash and is what makes the arithmetic work for the lender.
Every month
- The startup → The lender Repayment begins after a short interest-only period and consumes runway — the one resource the company cannot replace.
If the next round does not come
- The lender → The startup The lender ranks ahead of every shareholder and can take the assets, including the intellectual property.
- The startup → The equity investors Venture debt is senior. In a bad outcome the equity investors, not the lender, absorb the loss.
- Asset class
- Alternatives (private credit)
- Instrument type
- Senior secured loan plus warrants
- Traded
- Bilateral, held to maturity
- Typical users
- Venture-backed companies, specialist lenders, banks
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketmatters
- Creditdecides it
- Liquiditydecides it
- Fundingmatters
- Operationalmatters
What decides it here. The lender is really underwriting the last equity round's investors and their willingness to fund again. If they decline, the security is enforced against a company with little to seize.
3 · IntermediateHow it works in practice
How the return is built
What the symbols mean
- rthe interest rate, per year
- Tmaturity, in years
- Ean expected value
- Pa price, or a present value
- Dduration: how far a bond's cash flows sit in the future
- Lleverage, or a loss given default
- Coupons run several points above ordinary senior debt, but nowhere near equity returns.
- Warrants typically cover 5–20% of the loan amount in equity value. In a portfolio, a small number of large outcomes provide most of the excess return — the same power-law shape as venture capital itself, in a milder form.
- Losses are real and cluster when funding markets close. This is not a low-default asset class dressed as one; it is a moderate-default asset class with an equity kicker.
The covenant that matters
| Term | What it does |
|---|---|
| Senior secured, all-asset lien | Ranks ahead of equity — on assets that are often worth little |
| Material adverse change clause | Lets the lender act on deterioration before a payment is missed |
| Minimum cash / runway covenant | The real control: the lender can act while cash still exists |
| Warrant coverage | The upside, sized as a percentage of loan value |
4 · AdvancedPricing & valuation
The reflexivity: it works until funding stops
The entire model rests on the next equity round happening. That makes the asset class correlated with exactly the environment that determines its losses:
- In an open funding market, companies raise, loans repay, and losses look negligible. Reported loss rates in such periods flatter the strategy badly.
- When funding closes, many borrowers simultaneously cannot raise. Defaults arrive together, and the collateral — a partly built product and a team — is worth little in a market where nobody is buying.
- This is the same failure of a diversification assumption as everywhere in the risk measures page: fifty loans across fifty companies are one bet on the venture funding cycle.
What the 2023 banking episode revealed
Venture lending had been concentrated in a small number of specialist providers, several of them within a single bank whose deposit base was the same venture ecosystem it lent to. When that bank failed, the exposure ran in both directions at once — the depositors and the borrowers were the same community. The lesson is not about venture debt specifically but about correlated funding and lending books: an institution whose assets and liabilities respond to the same shock has no diversification at all, whatever the loan schedule says.
Where it sits for a borrower
- Against equity: cheaper if the company succeeds, because dilution compounds and interest does not. Dangerous if it does not, because debt has a maturity and equity does not.
- Against ordinary private credit: available to companies no cash-flow lender would touch, priced accordingly, and covenanted on runway rather than on leverage.
- The founder's real question: does this loan buy enough runway to reach a milestone that materially improves the next round's terms? If it merely delays the raise by four months, it has added a creditor without changing the outcome.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Venture Debt in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.