Venture Debt for Startups: A Deep Dive on Lines of Credit and Term Loans

A post your CFO will ❤: choosing the right product and lender for your startup

A few months ago, I shared some basic information on the role that venture debt has to play in strengthening a company’s bank account. That blog post focused on why to consider raising, how lenders differentiate themselves, what market rates look like, and what you can expect to negotiate with lenders. This post goes deeper on two of the most common forms of venture debt: revolving lines of credit and term loans.

At Inovia Capital, we’ve been educating ourselves and our portfolio company founders on this source of capital. Over the past decade, our portfolio companies have collectively raised over $300M in venture debt and credit facilities. We’re sharing the insights that we’ve learned across hundreds of term sheets, received by our portfolio companies, to better inform the broader startup community. In this post, I’ll provide more clarity on the different types of loan products, the relative trade-offs among those products, and the top considerations that our community of CEOs and finance leaders should keep in mind when evaluating different term sheets.

Debt Product Offerings

In my last post, I highlighted five different products: 1) revolving lines of credit (a line that the borrower can draw on when needed and pay down at will), 2) term loans (a lump sum repayment), 3) MRR lending (typically a line of credit where the amount available for borrowing is tied directly to the borrower’s MRR), 4) convertible debt (under certain conditions, the loan is not repaid but rather converted to equity, more commonly issued from large organizations that both invest and offer debt than from traditional FIs), and 5) products that smooth cash flows in anticipation of future income sources (ie. R&D tax credit financing and purchase order financing)

As mentioned above, in this post, I’ll go more in-depth on lines of credit and term loans; they often appear interchangeable, and a startup that’s seeking debt may get term sheets for both products without clearly understanding their differences. Of the other options, MRR lending can be quite similar to lines of credit and convertible debt is better compared against equity, while products which smooth cash flows in anticipation of future income sources are both less frequent for high-growth startups and clearly tied to a specific activity.

Line of Credit vs Term Loan

What CFOs need to consider when choosing a partner

In my last blog post, I covered common terms on which to evaluate a term sheet, including interest rates, forced drawdowns, and covenants. However, often CFOs will feel that they have a few good options with largely comparable terms. Three considerations tend to sway the decision in these situations.

1. The relationship with lenders. This often factors into the decision before even evaluating how the various term sheets will impact cash flow. Understand your lender, what they’re like to work with, and how they’ll likely react if you have a hiccup in your business. This is a multi-year relationship and you’ll be spending a significant amount of time reporting to this individual on your business.
2. The reliability of accessing capital. It’s rare, but still possible, to see uncommitted lines of credit. Rather than a committed line where you know the capital is accessible, uncommitted lines don’t require the bank to advance a loan. Uncommitted lines of credit tend to be priced cheaper than the committed ones. Treat these as LOIs rather than full term sheets. A more common term is a borrowing base formula, these are used to calculate the maximum capital you have access to. It’s quite routine to receive a term sheet for one number, with a borrowing base formula that would only grant you a smaller portion of that capital today. You can negotiate these formulas themselves, and try to secure a higher upfront multiple that provides you more capital earlier on.
3. The ability of a lender to grow alongside your business. Almost all lenders will require you to switch your bank accounts to them, and although it’s not worth killing a deal over this term, it is a pain point (especially when it influences payment from large enterprise customers). Furthermore, you’ll have to run a full process each time you seek debt funding (this is why we recommend raising debt alongside or immediately after an equity round). Your time can be better spent elsewhere, and a partner that can grow its debt offerings as your business grows can save you from going back out to market as new debt is required.

Special thanks to Ryan Levenberg at Q4 for helping me clarify some of these thoughts!