Sample Venture Debt Term Sheet

A venture debt term sheet is a document provided by a venture lender, and contains the terms and conditions for a venture loan. The term sheet is nonbinding, and summarizes the main points of the loan. Once your startup receives a term sheet, you can (and should!) negotiate terms before you sign the term sheet. To help our clients understand the term sheets they receive, we’ve create a sample sheet. For explanations of the different clauses, click on the “i” icon next to that section.

Note: this sample venture debt term sheet is provided for educational and informational purposes only. Companies raising funding should always work with an experienced attorney and CPA, and should not rely on this venture debt term sheet for actual legal or accounting advice.

Proposal

To meet the financing needs of STARTUP (the “Borrower”), LENDER (“Bank”) would like you to consider the financing proposal described in this proposal letter (the “Proposal”).

A term facility (the “Term Loan Facility”) in the amount of $5,000,000 (the “Term Loan Commitment.”)

Type and Amount of Facility

This is the amount that will be lent to you.

Why do startups take venture debt?

Four reasons to raise venture debt

Can you have two venture debt loans?

Dangers of venture debt

$5,000,000 fully available to be drawn at Close through the interest-only period.

Term Loan Availability

This is the amount of time your startup can draw upon these funds. If availability begins at a set date rather than “close’’ remember that it will take approximately a month to go through documentation. Your startup should put a loan in place well before you need it based on your burn rate and runway. We recommend putting a loan in place after an equity fundraise and drawing it down later. Getting a loan at that point is easier and you’ll get better terms. Most loans will have a long forward commitment of six to 18 months for the startup to draw the money down.

Please note that it’s better to draw the money down when your startup has some months of cash in the bank, rather than waiting until you are out of cash. Generally, your startup should draw the funds when you have about 3-6 months of cash available. If funds get tight and the bank has a Funding Material Adverse Change (MAC) clause (see On-Going Conditions) the bank could deny you funding that your startup was counting on.

What is the venture debt drawdown period?

Facility will have an interest only period for twelve (12) months from the Closing Date. Upon Borrower achieving the Milestone Event, interest only period to be extended to fifteen (15) months from Close.

During the interest-only period your startup can draw on the funds and only pay interest instead of loan amortizing payments as well. Interest-only periods are attractive because minimal capital is paid back to the lender during that time, which means the startup can use the capital. Please note that we don’t advocate waiting until the last minute to draw down funds. Note that in the current environment, interest rates are rising. Many startups ask for fixed rates, but banks and lenders are sophisticated and generally insist on floating rate deals. Note that banks and lenders do not let rates float below the interest rate stated when the deal was struck.

What do rising interest rates mean for startup fundraising?

Flat interest rate or deferred interest with final payment option

Milestone Event defined as Borrower achieving trailing 3 month (T3M) GAAP revenue of no less than $5,000,000.

Milestone events are often included in a deal to bridge the startup’s requests and the lender’s concerns. For example, a lender might decide it can extend the Interest Only Period or include more debt capital in a deal if the startup hits the Milestone. The startup knows that by hitting the Milestone, it gets a better deal so both parties benefit from the inclusion of a Milestone if there is a gap in negotiations. If the startup fails to achieve the Milestone, the lender rarely takes a negative action. The deal just reverts to the more conservative option. Lenders take negative actions when Covenants are breached which will be discussed later.

Following the interest only period, the term loan balances will amortize ratably over thirty-six months. Upon achieving the Milestone Event defined above, facility shall amortize ratably over thirty-three months.

Amortization of a loan means that Principal and Interest are paid back to the lender on a defined schedule. In this case, it’s 36 months but it will be shortened if the startup hits the milestone because the interest-only period will be extended.

4 years from Closing Date.

Typical loan durations are 3-4 years.

WSJ Prime*+1.00%, floating. The interest rate shall be subject to a floor of 5.75%.

• For reference, WSJ Prime is currently 4.75%

Interest shall be payable monthly, upon any prepayment due to acceleration and at final maturity.

A closing fee equal to 0.50% of the Term Loan Commitment Amount fully earned and payable at Closing.

The commitment fee compensates a lender for providing access to a loan. The lender is allocating, or holding, capital for the startup. Commitment fees are notoriously easy to negotiate down. The commitment, prepayment, and final payment fees all affect your startup’s cost of capital. We recommend getting several term sheets and reviewing the terms. You can use that information to negotiate the best deal.

Borrower may elect to retire the Facility in its entirety at any time by paying the outstanding principal balance, unpaid accrued interest, applicable Final Payment, and a Prepayment Fee. The Prepayment Fee shall be 3.00% of the outstanding principal balance if paid before the first anniversary of Loan Closing, 2.00% if paid after the first anniversary but before the second anniversary of Loan Closing, and 1.00% thereafter. Prepayment Fee shall be waived if Facility is refinanced by Lender.

Normally venture debt lenders will charge a small prepayment fee of 1-3% of the remaining principal outstanding. If there is a “Final Payment” component of the loan, that will also be due at the time of prepayment. The lender always wants to keep money outstanding and earning interest with strong companies. However, strong companies tend to prepay their loans. The prepayment fee ensures that the lender gets some return on the funds if they are prepaid. Prepayment fees, like commitment fees, are often easy to negotiate down.

Venture debt prepayment

6.00% of the Advanced Amount, due upon the earlier of Maturity or termination of the Facility.
Approximate IRR or “all-in” cost of capital of ~8.90% to include a floating rate of 6.75% (WSJ Prime - 4.75%) and a Final Payment of 6.00% due upon the earlier of Maturity or termination of the Facility.

A final payment lets the lender “backload” some of the loan’s interest and startups find this attractive. In general, it’s better for your startup to delay interest with a final payment than making larger payments during the term of the loan. It’s better to backload because three or four years after the startup puts this loan into place, it should be raising capital at a much higher valuation. Raising at a much higher valuation means that the percentage of the startup that would need to be sold in an equity fundraise to pay the debt is much lower and less dilutive.

Final Payments in Venture Debt

First priority lien on all assets with a negative pledge on intellectual property.

These are assets that are pledged to satisfy the loan if it goes into default. Typically a lender will request a lien on all assets of the company. The lender will benefit from the liquidation of assets if the company goes into default and a restructure can not be reached. A fallback position for the lender is to ask for a lien on all assets except for intellectual property. In that case, the lender will ask for a negative pledge on intellectual property (IP). The negative pledge means that the startup is prohibited from pledging its intellectual property to another lender. The negative pledge does not count as an actual lien, and if the company is sold, any proceeds from an IP sale are split among all the creditors. If the startup asks for a restructure later, it can offer to convert the negative pledge on intellectual property into an actual lien on IP.

What is a springing lien?

Negative pledge on IP

No Financial Covenant until Borrower has drawn $2,500,000 or greater on the Term Loan Facility. Once Borrower exceeds $2,500,000 in debt outstanding on the Term Loan Facility, Borrower will be subject to the Financial Covenant below:

Covenants are conditions to which the startup must adhere. Violating covenants puts the startup at the risk of default. When negotiating a loan a startup’s goal should be have as few covenants as possible in the term sheet. If any covenants are included, the startup should be sure it can clear those covenants.

While all covenants can be a problem for startups, revenue covenants can be particularly worrisome. If the startup misses its revenue, it will probably have an accelerated burn rate as well. The accelerated burn rate means the startup’s cash balance will shrink much faster than predicted. Once your startup misses a revenue covenant, you’re in default and at that point you have to play by the lender’s rules. In general, we advise clients to negotiate those out if possible. Affirmative covenants are goals your startup must achieve. Negative covenants restrict startups from taking certain actions, like borrowing more money or incurring liens.

Borrower to be subject to a trailing 3 month revenue covenant, tested monthly, equal to 60% of the latest BOD approved Operating Budget provided to Lender for FY’22 and FY’23. Specific levels to be documented in final documentation. For 2023 and thereafter, covenant levels to represent 60% of the latest BOD approved Plan provided to Lender and shall, in all cases, require minimum YoY growth rates of no less than 25%.

The Borrower and all subsidiaries guarantee all of the indebtedness, obligations and liabilities of the Borrower and its subsidiaries arising under or in connection with the Loan Documents and in connection with bank product obligations owed to the Lender and its affiliates.

If the Lender determines in its sole discretion that the Borrower’s investors will no longer financially support the Borrower, the Lender may declare an Event of Default. The Lender does not have to advance additional funds in the event of a Material Adverse Change.

Investor Abandonment Clause

The Material Adverse Change (MAC) clause gives the lender the right to call a default and the ability to seek remedies if an event adversely affects your financial position. When a lender invokes a MAC, the lender is claiming that something has changed and the borrower will likely not be able to repay the loan. Once the startup is in default, the lender can pursue remedies like foreclosure.

The bank will continuously review your financial position and if the burn rate is out of control, it can call a MAC default. We’ve seen lenders reference changes in the fundraising climate, large lawsuits, changes in management, etc as reasons to call a MAC default. MACs are ambiguous and therefore give the lender a lot of latitude to interpret and call a MAC default.

Investor Abandonment Clause (or Investor Support Clause) is another covenant that functions like a MAC but relies on the VC investors’ willingness to put more capital into the startup. The lender can call a startup’s investors to determine their level of commitment and whether they will invest more into the startup. If the company isn’t doing well or the investors don’t plan to provide more funding, the lender can call a default.

The Funding MAC is less severe than a full default, which could put the startup into foreclosure. The Funding MAC gives a lender wide latitude to refuse to allow the startup to draw more funds. While the Funding MAC is not a full default, if the startup is counting on those funds, it could have a very serious negative effect on the startup. Try to negotiate Funding MACs out of the term sheet, but if you can’t get one removed from the term sheet, consider drawing all the money up front or early in the loan to avoid the Funding MAC.

Investor abandonment clause

Material adverse change clause in venture debt