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.
- 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
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.
3 · IntermediateHow it works in practice
How the return is built
- 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.