A founder’s guide to venture debt for startups, with Mercury's Head of Credit

Chase Little

Startup founders often shy away from nontraditional or unexplored funding opportunities, especially after the Silicon Valley Bank (SVB) collapse which shunned most founders away from the once revered SVB venture debt

Venture debt or venture lending, is still a growing field, and many founders don’t have experience with it. So, we are here to demystify it and help you determine if it’s one of the alternative financing options you’ve been looking for

We sat down with Chase Little, Head of Credit & Venture Debt for Mercury. He’s worked in the venture debt industry and supported startup finances for over 15 years. Below, we dive into: venture debt meaning, the pros and cons of venture debt, and best practices for finding venture debt firms for startups.

It’s easy to get in touch with venture debt lenders — they’re always happy to talk to founders, investors, and board members. The key is that founders need to know what they want from the partnership and do their due diligence first.” - Chase Little, Head of Credit & Venture Debt for Mercury.

What is venture debt funding?

It's a fundraising model where a startup borrows money from a bank or non-bank lender to fund working capital or capital expenses. Unlike equity financing, venture debt lenders have little financial upside in the company.

  • Startups must repay the debt with inflows of cash in the business. 
  • It sits on your balance sheet as a liability and usually has a maturity of 3 to 4 years. 

The venture debt market has become quite large over the years, so the types of debt available under the phrase have expanded. 

Venture debt vs venture capital

Venture debt is generally used to complement equity financing and it serves to provide startups with additional capital without diluting the ownership stake of existing shareholders. Because it is non-dilutive, it is sometimes the preferred alternative to venture capital. 

Venture capital, on the other hand, involves investors providing funding in exchange for equity ownership. This form of financing is typically more suitable for startups seeking significant capital injections for rapid growth.

What stage should you consider venture debt for startups?

Venture debt is typically best for startups who’ve already found product-market fit. With that, investors are more willing to join in on early-stage venture debt.

That means they’re most likely at a Series A funding round or beyond. But there are some exceptions. 

For instance, life science and ag tech business models require a lot more capital to build a viable product. So, venture debt firms may finance some seed rounds. 

However, more uncertainty is attached to a seed round than a Series A or B funding round. To account for this, founders should ensure their debt partners are comfortable with downstream pivots and alterations that are not underwritten yet. 

The pros and cons of venture debt

Pro: It’s primarily non-dilutive. Non-dilutive funding means the cash has lots of uses, just like equity. Founders and equity holders retain more ownership and have a longer runway. 

Con: Your business can get over-levered. If you take on too much debt, it burns the business, and you can’t make payments. The venture debt lenders will still take action to ensure they get paid, which can slow your growth plan and potentially harm future equity. 

Fortunately, those cons only occur if you take out too much debt, too soon. Plus, for the most part, good lenders only offer the appropriate amount of leverage for your startup. 

Why is venture debt important for startups?

In Chase’s words, “Venture debt is like a Swiss Army knife.” It has multiple uses. 

Here are some examples of great matches between venture debt and business purpose: 

  • SaaS businesses — If you have formulaic unit economics, using debt instead of equity makes sense because your business is predictable. The differentiators here are your sales and marketing. 
  • Hardware businesses — If you require a lot of equipment or facilities, venture debt makes for good insurance, which vendors love if you want longer and more flexible terms. 

Ultimately, the best use cases are situations in which the business both: 

  • Wants to raise for long-term R&D
  • Has plans that’ll produce returns in the short term

If you’re only looking for short-term working capital, better debt options exist. 

A four-year repayment window would be medium-term: when you’re looking at projects that won’t be monetized for a few years, but you still need a plan to have cash on hand. 

“Venture debt financing is appropriate when you’ve hit that identifiable, near-term inflection point in your business and are now ready to scale.” - Chase Little, Head of Credit & Venture Debt for Mercury

3 best practices for securing venture debt funds for your startup

1. Evaluate every option before you commit

For founders who are new to debt funding, Chase, from Mercury Venture Debt, recommends shopping around. Be aware of all of the options out there before committing to anything. 

He often sees people approach debt funding differently from investments; they treat raising equity like a low-stakes vendor relationship. 

But the reality is: Four years is a long-term commitment in startup land. 

That is why it’s crucial to ensure your debt partner will: 

  • Give more to your startup than just money
  • Patiently understand what it’s like to be a startup founder

Yes, there can be negative press around venture debt companies that are expensive or punitive, especially with top venture debt firms.

However, as long as you vet all the incentives, most banks and traditional venture lenders will not hamstring founders that way. 

2. Identify the right venture debt funding for your startup

Venture debt options can be affordable or high-ticket, come from traditional banks or neobanks, and so on. 

To streamline the lengthy search, clearly envision what you want from taking on this debt. Instead of fielding proposals from dozens of venture debt providers, focus on questions like: 

  • What are my goals (both short-term and long-term) for this venture debt fund? 
  • Why do I believe venture debt financing is the best path to accomplishing them? 
  • How much debt do I need to take out to make this happen? 

3. Prep for taking on venture debt funds

Start by checking in with your board. You don’t want to dedicate time to finding the right venture debt provider — only to discover that your board doesn’t support the move. 

If your board okays the decision, have your diligence materials ready to go. Venture debt is often placed right after an equity raise, which is convenient because the major materials you’ll need are a forecast, a pitch deck, and a cap table. 

You’ll be prepped to run an efficient process and secure the best terms for your startup. 

“I love it when founders shop around. I think it’s so important to find out what options are out there and see all the differences.” - Chase Little, Head of Credit & Venture Debt for Mercury

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