How to read a typical venture debt term sheet

If you've raised venture capital recently or you're currently raising, you might be thinking about getting venture debt, also called a venture term loan. If you are, you might see a term sheet soon. This is a nonbinding agreement that a venture debt lender will give you when they’re considering an investment in your company.

This sheet will set the terms of your deal, including the size of your loan, your interest rate, and the warrants that your lender will take. It will also set the tone for your company’s future, whether it’s when you take on your next VC round or when you look into other forms of financing. With so much riding on the term sheet, there’s no question that the agreement should be negotiated to ensure that you’re safeguarding your company’s best interests.

Venture debt deals have been on the rise in recent years, according to data from Pitchbook. Once you've grasped the basics of venture debt financing, it's time to understand what you'll find on a typical venture debt term sheet. In this article, we’ve decoded the meaning behind the most important terms you should know before negotiating and signing your term sheet.

Every venture debt term sheet includes the same core components, but the specifics vary by lender and deal structure. Before diving into negotiations, you should understand the terminology on a venture debt term sheet.

Check out a venture debt term sheet example here.

‍Loan size

The loan size, also known as a loan commitment, is the total amount that you receive from a venture debt facility. It’s usually between 20–50% of your previous venture capital round. For example, if a startup raised $5M in its last round, it might be able to get a venture term loan in the range of $1–2.5M.

Interest rate

The interest rate on a venture term loan is generally variable, meaning the startup will have to take on interest rate risk. Many venture debt rates are based on the WSJ Prime rate, which fluctuates in direct correlation with the Fed rate.

Loan fees

Loan fees are miscellaneous fees that some lenders charge, sometimes triggered as soon as a loan is closed. In general, these upfront fees are lower than what traditional commercial loans charge since the goal of a venture term loan is to help startups burn as little cash as possible.

Hence, some loan fees are due at the end of the loan duration, known as the maturity date. In this case, these fees are often known as final payments and are usually quoted as a percentage of the total loan amount.

Some lenders also choose to charge an optional loan fee called a prepayment fee if you repay your venture term loan prior to the maturity date. These fees may be structured to be lower if you prepay your loan closer to the maturity date.

Loan duration

The loan duration refers to the total time from when the loan is closed to when it is fully repaid. Venture term loans typically have a loan duration of 3–5 years. For example, the loan offered through Mercury has a duration of 48 months. The loan duration can also be broken up into the draw period, the interest-only period, and the principal repayment period.

Draw period

The draw period, also known as the availability period, is the period of time during which a company can draw down on its loan after closing a venture deal. Interest is not charged during this period if the loan is not drawn. The draw period differs based on the lender. 

Interest-only period

The interest-only period is a duration of time — starting when your deal is closed and typically running 12–18 months — during which a company is only required to pay interest on a loan. During this period, a startup only has to pay interest (not the principal). The longer the interest-only period, the more time a startup has before it needs to start paying off its loan.

Interest charges only begin once a loan is drawn. For example, your startup might wrap up a venture debt agreement in September 2021. Your interest-only period will begin then, but you won’t actually be charged interest until you draw your loan in March 2022. Note that the draw period and interest-only period will often closely overlap.

The length of the interest-only period tends to influence the price of the loan (the interest rates and the warrant pricing). Some lenders allow startups to negotiate conditional extensions if their startup hits certain performance milestones.

Amortization

Amortization refers to how a loan’s repayment schedule is determined. Venture term loans often follow straight-line amortization, meaning the principal repayment is spread out equally over a certain period (after the interest-only period).

For example, a 4-year $4M venture term loan may have a 12 months/36 months amortization structure. In this case, the interest-only period and draw period directly overlap, both taking place over 12 months, followed by 36 months of monthly principal repayments. Under a straight-line amortization repayment structure, each monthly principal repayment would amount to about $111,111.

Collateral

For lenders, collateral serves as a “last resort” source of repayment. If you haven’t been able to repay your loan, a lender might ask for your business assets — depending on what you’ve agreed upon in your term sheet, this might also include intellectual property. Collateral can be enforced via liens.

Warrants

Venture debt warrants give their holder the legal right (but not the obligation) to purchase a certain number of shares of the company’s stock at a fixed price, known as the strike or exercise price. Warrants work like the equity options you might give out to employees — they give your lender the option to buy a small portion of your company, valued at the time that the loan was created. The warrant duration is most commonly 10–12 years but could go as long as 15 years. It is also longer than the loan duration. The lender will specify the class of shares for the warrant (Preferred or Common), but this arrangement is negotiable.

Covenants

Covenants are terms and conditions imposed by the lender that can lead to a default if violated. The Office of the Comptroller of the Currency (O.C.C.) acknowledges that venture debt lenders are taking on more risk. It includes covenants in its guidance to lenders as a way to mitigate risk.

Covenants can either be positive or negative. Positive (sometimes known as affirmative) covenants are lists of actions the startup promises to undertake. These might cover things like following all regulatory and reporting requirements, obtaining relevant approvals, filing taxes appropriately, or sticking to certain financial ratios.

Negative covenants are things the startup promises not to do, like selling the business or taking on additional debt.

You can think of covenants as either “light” (less restrictive) or “heavy” (more restrictive). For earlier-stage startups where your financial performance is less predictable, heavy covenants can be problematic. A single bad quarter could trigger a default on your covenants, even if your company is otherwise healthy. However, you have to keep in mind that lighter covenants may come with a higher interest rate to offset the lender’s risk.

Material adverse change (MAC) clause vs. Investor abandonment clause

One major component of any loan agreement is the set of rights granted to a lender that allows them to take action if the company fails to meet its obligations as laid out in the venture term loan agreement. These rights are stipulated in the form of either a MAC clause or an Investor abandonment clause. While most lender agreements include a MAC clause, Mercury gives companies the option to choose the clause they prefer for their loan agreement.

A MAC clause gives a lender the right to call a default if it is deemed that (i) there have been fundamental changes to the company’s business, operations, or conditions, or (ii) the company's ability to repay any of its obligations has been impaired. 

Some lenders may permit the substitution of an Investor abandonment clause in place of the MAC clause default. This clause gives a lender the right to call a default if it is deemed that the company’s investors have made it clear that they do not intend to continue funding the business in the amount and time frame necessary to enable the company to meet its loan obligations. In essence, if a borrower reaches a point where they are unable to repay any of their obligations to the lender — and subsequently, to other creditors — and their investors have refused to fund the business or help the borrower with a “soft landing” (e.g., selling the business or winding it down), the lender would have the right to call an Investor abandonment default. 

It’s important to note that the likelihood of a lender calling a MAC or Investor abandonment default is very low.

Finally, because covenants can be restrictive (e.g., mandating the startup to not breach certain financial parameters), heavy covenants may not be appropriate for earlier-stage startups, where financial performance is less predictable. As a trade-off to having no financial covenants in place, lenders often require compensation in the form of warrants.

Venture debt can be structured in different ways. How and when you repay the principal can significantly impact your cash flow and runway. 

Bullet loan

A bullet loan requires you to pay only interest throughout the loan term. The entire principal is due in a lump sum at maturity, called a “balloon payment.” This structure is good for cash flow since your monthly payments stay low until the end.

Bullet loans make the most sense for companies anticipating a significant liquidity event before the loan matures, like an acquisition, IPO, or large funding rounds. They also work well for startups that can't afford large monthly payments, as long as they have a plan to pay back the principal at maturity. 

Since lenders take on more risk with bullet structures (they're waiting longer to recoup the principal), these loans may have higher interest rates or warrant coverage. You can negotiate by demonstrating a clear path to repayment, whether that's a fundraising timeline or projected revenue milestones.

Amortizing loan

An amortizing loan spreads principal repayment across regular installments over the term of the loan.

This structure makes sense for companies with predictable, recurring revenue that can handle steady monthly payments. Startups that aren't planning on a specific liquidity event often prefer amortizing loans because they build a track record of debt repayment — which is useful for establishing business credit for future financing.

If you’re trying to reduce your monthly payment, try to negotiate a longer amortization term. However, this will also increase your total interest costs.

Hybrid loan

A hybrid loan combines elements of both a bullet loan and an amortizing loan. You’ll typically have an interest-only period followed by partial amortization, with a remaining balloon payment at maturity. This structure lets you preserve cash during the first part of the loan while also paying down principal.

If you need to maximize your runway now but expect your cash position to improve over time, a hybrid loan might be your best option. They work particularly well when you're confident in your revenue growth, but want to give yourself a cushion before making amortized payments. You’ll also have a smaller final balloon payment than a bullet loan, since you’ll make some principal and interest payments for a period of time.

While some terms of a venture debt loan are standard, others have room for negotiation — especially if you’re prepared.

Start early and gather multiple offers

Your negotiating position is strongest right after closing an equity round. You have fresh capital, investor support, and a strong financial position. 

Try to collect at least two venture debt term sheets before committing to serious negotiations. If you have multiple offers, you’ll have a better idea of the current market. Plus, you’ll have the leverage to ask for more favorable terms, like “Another lender offered 15 months interest-only. Can you match that?”

Know your priorities

How do you plan to use the capital? Is it more important to you to have low monthly payments, or to minimize the amount of interest you’ll pay? Do you need flexible covenants, or can you handle a loan with more stringent terms?

You need a clear understanding of your priorities and your projected growth before you start negotiating. The terms you’re willing to accept will often dictate what lenders you can work with. 

Focus on the terms that are actually flexible 

You can often negotiate the length of the interest-only period, warrant coverage, and covenants. You might also be able to get a lender to reduce commitment fees and eliminate prepayment fees. 

However, some requirements are standard across deals, like collateral and basic financial reporting. Don’t spend your energy trying to negotiate terms that most lenders won’t budge on.

Evaluate the lender, not just the terms

You get two term sheets. One has fewer covenants and is from a reputable lender, but has a higher interest rate. The other has more restrictive covenants, a lower interest rate, and a lender without a proven track record of working with companies like yours.

Ask other founders in your network if they’ve worked with a particular lender before. Ask how they handled bumps in the road, because that's when lender relationships really matter.

The best time to explore venture debt is before you need it. Starting conversations with lenders while your equity round is closing (or shortly after) puts you in a stronger negotiating position. You’ll also have more breathing room to compare offers without pressure.

Remember that securing a venture debt loan is only the beginning. The lender you choose will be tied to your business for years. How the lender manages their relationships with borrowers matters as much as the terms they offer.

Warrants

Venture debt warrants give their holder the legal right (but not the obligation) to purchase a certain number of shares of the company’s stock at a fixed price, known as the strike or exercise price. Warrants work like the equity options you might give out to employees — they give your lender the option to buy a small portion of your company, valued at the time that the loan was created. The warrant duration is most commonly 10–12 years but could go as long as 15 years. It is also longer than the loan duration. The lender will specify the class of shares for the warrant (Preferred or Common), but this arrangement is negotiable. 

Learn more about Mercury’s Venture Debt loan product.