Credit & Lending

How to Underwrite Venture Debt

Underwrite venture debt on runway and investor support rather than cash flow. Measure cash on hand against monthly burn, judge the likelihood the equity sponsors fund the next round, and size the loan as a fraction of recent equity raised. Enterprise value coverage, revenue quality and an exit path determine downside recovery.

What makes venture debt underwriting different

Venture debt lends to companies that are burning cash, have little collateral and may not be profitable for years. Repayment comes from future equity rounds, eventual profitability or a sale of the company, so the lender is underwriting the probability that the company keeps raising capital. Value comes from interest, fees and warrants that give the lender modest equity upside. Risk comes from burn outpacing plan, venture investors declining to support the next round, and a liquidation in which intellectual property and customer contracts recover far less than the loan. The quality of the venture sponsors is part of the credit.

A venture lender looks at runway, the strength and reserves of the existing investors, enterprise value coverage based on the last round and revenue multiples, and the lender's ability to take control of cash and IP if things go wrong. Equity investors see venture debt as a way to extend runway with less dilution, but they weigh covenants, warrants and the risk that the lender acts against the company when a round slips. Founders often underestimate how quickly a material adverse change clause or a minimum cash covenant can restrict operations once performance misses plan.

Key metrics

Cash runway

Months of cash at current burn show how long the company can operate before needing new capital or hitting covenants.

Lenders commonly want at least 12 months of runway including loan proceeds, often more.

Net burn rate

Monthly cash consumption drives runway and signals whether the company is moving toward breakeven.

Loan size relative to last equity round

Sizing against equity raised ties the loan to investor conviction and enterprise value.

Venture debt is often sized at roughly 20% to 35% of the most recent equity round.

Loan-to-enterprise value

In a sale or wind-down, recovery depends on the company being worth well more than the debt.

Lenders typically prefer loan-to-value below roughly 10% to 20% of the latest valuation.

Revenue growth and gross margin

For later-stage borrowers, durable revenue and margin make the business financeable on its own merits.

Warrant coverage

Warrants provide equity upside to offset losses on failed credits across the portfolio.

Warrant coverage often runs in a range of about 5% to 15% of the loan amount.

How to underwrite it, step by step

Review the cap table, recent financing terms and the reserves and track record of lead investors.
Analyze monthly financials, burn, runway and the operating plan through the next financing.
Interview management and existing investors about strategy and willingness to support the company.
Assess enterprise value and the realistic sale value of IP, customer contracts and technology in a downside.
Size the loan, draw schedule and interest-only period against runway and the next milestone.
Negotiate covenants, warrant terms and a security interest in all assets including IP or a negative pledge.
Monitor monthly reporting and investor updates after closing.

Due diligence checklist

Capitalization table and equity financing documents
Monthly financial statements and bank statements
Operating plan and forecast
Board materials and investor updates
Customer contracts and revenue concentration data
IP schedule and assignment agreements
Existing debt and lien search
Investor support or comfort discussions summary
Warrant agreement draft
Account control agreements

Key risks and mitigants

Investors do not fund the next round

Lend to companies backed by investors with reserves and a track record of supporting portfolio companies, and set performance milestones for later draws.

Burn exceeds plan and runway shrinks

Use minimum cash or revenue covenants, monthly reporting and draw conditions tied to milestones.

Low recovery value in a liquidation

Take a lien on all assets including IP, keep loan size small relative to enterprise value, and secure control of deposit accounts.

Revenue concentration in a few customers

Diligence contract terms and renewal risk and size the loan below what one customer loss would support.

Subordination to later senior lenders

Restrict additional debt and liens in the loan agreement.

Typical financing and deal structure

Venture debt is usually a senior secured term loan with an interest-only period of several months to a year followed by amortization, a total term of three to four years, and a floating or fixed coupon plus upfront and final payment fees. Lenders receive warrants priced at or near the last round. Facilities often have tranches available on hitting revenue or financing milestones. Security covers all assets, sometimes with a negative pledge on IP instead of a direct lien. Covenants range from none to minimum cash, revenue performance or a material adverse change clause, which lenders use as protection when performance deteriorates. Revenue-based financing and asset-based lines are alternatives for later-stage, revenue-generating companies.

Red flags

Lead investors without reserves or reluctant to support the company
Runway under 12 months even after loan proceeds
Burn increasing without corresponding revenue growth
IP not properly assigned to the company
Use of proceeds to repay existing debt rather than fund growth

Frequently asked questions

How much venture debt can a startup raise?

Lenders commonly size venture debt at roughly 20% to 35% of the most recent equity round, adjusted for runway, revenue and investor quality. Later-stage companies with meaningful recurring revenue can sometimes borrow more based on revenue multiples. Lenders also keep the loan small relative to enterprise value so a sale would comfortably repay it.

What are warrants in venture debt?

Warrants are rights to buy company stock at a fixed price, granted to the lender as part of the financing. They give the lender equity upside to offset losses on loans to companies that fail. Coverage is usually expressed as a percentage of the loan amount, and the exercise price is often set at the price of the last equity round.

Do venture debt loans have covenants?

Many do, though terms vary. Earlier-stage loans may have few financial covenants but include a material adverse change clause. Later-stage loans may include minimum cash, minimum revenue or liquidity covenants. Borrowers should read these carefully, because a lender can use them to accelerate the loan or restrict activity if performance falls short.

When does venture debt make sense for a company?

It usually works best right after an equity round, when a company has recent investor validation, a clear plan and milestones to reach before the next round. It can extend runway with less dilution than raising more equity. It is a poor fit for companies with uncertain funding or no path to revenue.

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Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.