Venture Debt: How Lenders Decide You Will Make Your Next Raise
Venture debt can look like the cheapest money you will raise. But the lender is underwriting one thing above all: whether you will raise your next equity round. Understand that and you will know when to take it and when to leave it.
In this guide
Venture debt can look like the cheapest money you will ever raise: a loan, no board seat, and only a small slice of equity through warrants. But behind the term sheet sits one question the lender cares about more than any other. Will you raise your next equity round? That, more than your product or your team, is what they are underwriting. Understand it and you will know when venture debt is a smart way to extend your runway, and when it is a trap.
Why your next raise is the lender’s real question
Venture debt is lent to companies that are still burning cash. There is no profit today to repay it from, so it gets repaid out of future cash, and for most venture-backed companies that future cash comes from the next equity round.
So when a lender looks at you, they are really asking whether you will still be fundable in eighteen months, when the loan starts to come due. If the answer is yes, the loan is low-risk for them and cheap for you. If the answer is no, they are lending into a company that may not be able to pay them back, and they price and structure the deal to match.
What lenders actually look at
A few things carry most of the weight.
- Your existing investors. This is the biggest factor. Lenders want reputable equity investors with money still in reserve and a track record of backing their companies again. A strong, well-resourced cap table is the closest thing there is to a signal that the next round will happen.
- Your runway and the milestone the debt funds. The debt should buy enough time to reach a milestone that makes the next round more likely and larger, not just keep the business alive for a few more months. Losing sight of that turns borrowed time into the cash-flow panic it was meant to prevent.
- Your growth and your numbers. Revenue growth, retention, and how efficiently you turn cash into growth all speak to whether you are on a fundable path, which is the same thing investors check in your model.
- Cash and covenants. Expect conditions: a minimum cash balance you have to hold, sometimes a revenue covenant, and a clause that lets the lender act if the business deteriorates badly.
The best time to borrow is when you least need it
The strongest time to raise venture debt is right after you have closed a good equity round, when your cash is high, your investors are freshly committed, and you look most fundable. That is exactly when lenders compete to offer you the best terms.
The worst time is when the money is nearly gone and you are hoping debt will bridge you to a round that is not yet in sight. By then you are exactly the borrower a lender wants to avoid, and the terms, if you are offered any at all, will show it.
What it means if the raise does not come
This is the part to be honest with yourself about. Venture debt assumes a next round. If that round does not come, the loan does not go away. You still owe the money, the covenants still bind you, and the repayments compete with payroll for the cash you have left. A company that borrowed on the assumption of a raise that then fell through can end up in a far worse position than if it had never borrowed at all. The default-alive question, whether your own revenue could carry you, matters more once you have debt on the books, not less.
How to use venture debt well
Used well, venture debt extends your runway to a clear milestone: the revenue or product proof that makes your next round easier and bigger. Size it to that milestone, not to the gap you are trying to plug. Read the warrants and the covenants as carefully as the interest rate, because that is where the real cost and the real risk sit. And take it when you are strong enough not to need it, which is also when it is cheapest. If venture debt is the only thing standing between you and running out, it is postponing a reckoning, not extending your runway.
What this means for founders
Venture debt is genuinely useful, and genuinely cheap, when a next round is likely. It is dangerous when it is standing in for one that is not. The lender knows this, which is why they underwrite your fundability before anything else. The founders who use it well borrow when they are strong, size it to a milestone, and never lean on it in place of a business that can stand on its own.
If you are weighing venture debt and want a clear read on whether it fits your situation, and on what the terms are really costing you, book a consultation. We help founders across Africa and the diaspora make that call with the numbers in front of them.
FAQ
Frequently asked questions
How do lenders decide whether to offer venture debt?
Above all they assess whether you will raise your next equity round, because that is where the money to repay them usually comes from. They look hardest at the quality of your existing investors and whether they have reserves to follow on, then at your runway and the milestone the debt funds, your growth and retention, and the covenants that protect them.
When is the best time to raise venture debt?
Usually right after closing a strong equity round, when your cash is high, your investors are freshly committed, and you look most fundable. That is when lenders compete and terms are best. The worst time is when the money is nearly gone and you are hoping debt will bridge you to a round that is not yet in sight.
What happens to venture debt if you cannot raise your next round?
The loan does not go away. You still owe it, the covenants still bind you, and the repayments compete with payroll for the cash you have left. A company that borrowed on the assumption of a raise that then fell through can end up worse off than if it had never taken the debt, which is why you should only take it when a next round is genuinely likely.
What are warrants and covenants in a venture debt deal?
Warrants give the lender the right to buy a small amount of equity later, at a set price; they are part of how the lender is paid. Covenants are conditions you must keep to, such as holding a minimum cash balance, plus a clause that lets the lender act if the business deteriorates badly. Read both as carefully as the interest rate, because that is where the real cost and risk sit.
