The 10 Key Negotiation Points in a Venture Loan
So you are looking to scale up your business and need to come up with additional cash, but you aren't eager to sell more of your company to investors. Venture debt may be an alternative method of financing your growing company. Typically, venture debt is used to finance growth and provide working capital to companies without diluting the equity of existing shareholders. As opposed to venture capital investors who receive equity interest in the company, a lender will typically ask for a security interest in your Company's assets as collateral for the repayment of the loan.
The process of obtaining venture debt is similar in many ways to taking out a mortgage on your home. It is therefore important to be familiar with certain key concepts and know where you can negotiate more favorable terms. The loan itself obviously comes with all sorts of strings attached. The following is a short list of the terms to be aware of when negotiating a venture loan:
Type of Loan. There are two primary types of venture loans. The first is a term loan, which in principal is quite similar to a mortgage in that you receive a lump sum in one or two installments and repay the principal plus interest over a fixed period of time. The second type is a revolving line of credit or an accounts receivables financing. This form of loan is more common when a Company has recurring revenues from its customers but needs greater cash liquidity.
Loan Amount, Interest Rate and Minimum Drawdown. These details are usually the first to come to mind when thinking about a loan. Sometimes a loan is needed to solve an immediate cash need while other times the available credit provides a support cushion. Careful consideration should be made not only to how much money you need, but when you need the money and how much you will need at a time. In a revolving line of credit the maximum loan amount is usually tied to the company's receivables (money owed to the Company by customers) and therefore fluctuates as business goes up or down.
Payment Schedule. A term loan is paid back over a fixed period of time which is generally split into (1) an initial limited period of interest only, followed by (2) a longer period of principal plus interest. The length of each period is negotiable and will usually factor into the interest rate the lender is willing to give.
Collateral. In order to secure its status as a senior creditor in the event of a default, in most cases the lender will ask for a blanket lien over all assets of the Company. Depending on the size and type of loan, this can be subject to negotiation, and exceptions for certain assets may be agreed upon.
Warrant Coverage. While the lender typically doesn't take an equity interest, there is a desire to benefit from the upside of a successful company and reward the risk taken by the venture lender. The warrant value is usually calculated as a percentage of the loan amount and entitles the lender to purchase equity and share in a small piece of the profits in a distribution event.
Covenants. Simply put these are a list of the do's and don'ts while you owe the lender money. The don'ts tend to be similar in scope to the list of veto rights demanded by equity investors, while the dos are a list of compliance requirements including delivery of financial information and maintenance of insurance coverage.
Default Events. The list of events constituting a 'default' and the exact circumstances of each event are subject to negotiation but will almost always include any failure to make payments when due, whether to the lender or to any third party. It is also common to see a 'cross-default' provision with respect to a company's most important agreements, which means that any default under those agreements would also be considered a default under the loan agreement. Most loans contemplate an increased interest rate if the Company defaults on its obligations under the loan as a penalty.
Fees. In order to sweeten the deal for the lenders, there are numerous fees and expenses tacked onto the loan which the Company is expected to pay. In addition to the monthly loan payments, an initial fee is incurred for the right to receive credit, also known as a commitment fee. Another standard fee is a final payment fee which is paid when the loan is fully repaid. It is also common to have a pre-payment fee which is incurred should you decide to pay off the loan early, including in the event of a loan refinancing or an exit. In each case these fees are generally calculated as a percentage of the loan amount, and are almost always negotiable.
Reporting Requirements. As noted above, part of the covenants include ongoing reporting to the lender, including delivery of financial information which may be more onerous than the reporting already being made to the Company's shareholders. Generally, the financial information will cover important aspects of the business and allow the lender to assess the financial health of the company and its assets. There are also requirements to keep the lender informed of the location of the Company's assets, the addition of any new assets, the existence of legal proceedings and other significant developments in the business.
Banking. If the lender is a bank, you will usually be required to maintain your accounts with the bank or their affiliates. If the lender is not a bank you will likely be asked to agree to an account control agreement between your bank and the lender which gives the lender access to your accounts should you ever default on your loan.
The specific offering with respect to each of the foregoing terms will ultimately be subject to the risk profile the lender creates for your company based on its own internal review. The lower risk you are perceived to pose the more flexibility the lender will show in their proposed terms.
Just as you would negotiate a term sheet with an equity investor or shop terms for your home mortgage, we recommend that you seek advice to negotiate the terms of your venture debt financing. Understanding the terms above and negotiating at the earliest stages can often lead to significant savings in the long run.
Avi Anouchi is an associate at Yigal Arnon & Co. with nearly a decade of experience in M&A, venture capital and venture lending transactions.