Venture Debt Explained: Why It Is Priced Like a Loan but Underwritten Like Equity, and Why the Warrant — Not the Coupon — Is Where the Lender Actually Gets Paid
Michael King, PE Investment Manager · 8 min read ·
- Venture debt is a term loan to a VC-backed, usually loss-making growth company, provided alongside or shortly after an equity round. It is not underwritten to cash flow or hard assets — the company has neither — but to the quality of the equity syndicate and the runway to the next round
- It is sized off the last equity round, conventionally around 25-30% of it. A company that raised £40M might take £10-12M of venture debt, buying roughly six to twelve extra months of runway without issuing more shares
- The coupon is 8-15% all-in (typically a floating base rate plus a 6-9% margin), but the coupon is not the point. The lender also takes warrant coverage of 5-20% of the loan amount — the right to buy equity at the last round’s price — and that warrant is where a venture debt fund actually makes its return
- To the borrower, the attraction is dilution: warrants cost roughly 1-3% of equity against 15-25% for an equivalent equity raise. Venture debt is a complement to equity, never a substitute — no lender writes it without a strong sponsor behind the company
- The risk is asymmetric and time-shifted. A minimum-liquidity covenant and a material-adverse-change clause do nothing while the company is funded, then bite exactly when the next round fails to arrive. The 2023 collapse of Silicon Valley Bank showed how concentrated that risk had become
A Loan to a Company With No Cash Flow and Nothing to Secure It
Venture debt is a term loan extended to a venture-backed company that is burning cash, has no profits to service interest and no meaningful assets to pledge. Every instinct from corporate credit says the loan is unmakeable — there is no EBITDA to lend against and no collateral to recover. Yet it is a real and growing market, because the lender is not underwriting the things a normal lender underwrites.
What it underwrites instead is the equity behind the company. A venture debt fund lends to a business that a credible venture investor has just funded, on the theory that the same investors will fund it again, and that the loan will be repaid out of the next equity round rather than out of operating cash flow. The credit question is not “can this company generate the cash to pay me back” but “will this syndicate keep writing cheques, and how long is the runway if they pause.” That single substitution — sponsor support and runway in place of cash flow and collateral — explains everything else about how the instrument is priced and where its risk sits.
Sizing: Roughly 25-30% of the Last Equity Round
The loan is sized off the most recent equity raise, not off any balance-sheet metric, and the working convention is around a quarter to a third of it. A company that has just closed a £40M round can typically raise £10-12M of venture debt; individual facilities in the market run from about $1M for early-stage names to $50M-plus for late-stage ones. The logic is that the debt should be small enough that the equity investors — who sit behind it — remain comfortably in control of the outcome.
What that money buys is time. A £10M facility on a company burning £1.5M a month is roughly six to seven months of additional runway, and that is precisely the pitch: reach the next milestone, and therefore the next valuation, before going back to the equity market. The instrument is closer in spirit to recurring-revenue financing than to a leveraged loan, but where that product is underwritten formulaically to a multiple of ARR, venture debt is underwritten to the softer judgement of whether the equity story still holds.
The Coupon Is 8-15%, but the Warrant Is Where the Lender Gets Paid
The headline cost is a floating rate — a base rate such as SOFR or the Bank of England base rate plus a margin of roughly 6-9%, landing all-in around 8-15% in the current environment, and above 20% for the riskiest names. On top of the coupon sit an arrangement fee of around 1% at closing and an end-of-term fee, often 2-3% of principal, payable when the loan is repaid. Terms have shortened as rates rose — lenders now write two-to-three-year facilities where they once wrote three-to-four — usually with an interest-only period up front before amortisation begins.
None of that is where the money is made. A single-digit default on a portfolio of cash-burning startups would wipe out a low-teens coupon, so the coupon is essentially compensation for the money at risk, not a profit. The profit is the warrant: the lender takes coverage of 5-20% of the loan amount — the right to buy shares at the last round’s price — and on the deals that succeed, that option is what lifts a low-teens loan into a high-teens or better blended return. Warrant coverage is not a sweetener bolted onto a loan; it is the reason a rational lender makes the loan at all.
| Cost of a $10M, 3-year facility | To the borrower | To the lender |
|---|---|---|
| Coupon (base + ~7.5% ≈ 12%) | ~$1.2M / year | Covers cost of capital and losses |
| Arrangement fee (~1%) | $100k at close | Fee income |
| End-of-term fee (~3%) | $300k at repayment | Fee income |
| Warrant coverage (10%) | ~1-2% dilution | $1M of upside, worth $2M+ if the company doubles |
Read the table from the right-hand column and the instrument makes sense: the coupon and fees keep the lights on, and the warrant is the return. Read it from the left and the borrower sees a loan whose sticker rate is high but whose true equity cost — the warrant dilution — is a fraction of what an equity round would cost. Both readings are correct, and the gap between them is the whole product.
Why Founders Take It: Runway Without the Dilution of a Round
The case for the borrower is dilution arithmetic. Raising £10M of equity at a £40M pre-money valuation hands over 20% of the company; raising the same £10M as venture debt costs the warrant — roughly 1-3% of equity — plus interest that is repaid in cash. If the extra runway lets the company reach its next round at a materially higher valuation, the founders have bought time with a small slice of equity instead of a large one, and the debt is repaid out of a raise done on far better terms.
This is why venture debt is a complement to equity and never a replacement for it. The whole model rests on there being a next equity round to repay the loan; a company that cannot raise equity cannot support venture debt, and no lender will provide it without a committed sponsor already on the register. Set against the permanent, non-repayable capital of growth equity, venture debt is cheaper and less dilutive precisely because it is riskier for the borrower — it has to be paid back, on a schedule, whether or not the milestones land.
The Covenant That Bites When the Next Round Doesn’t Come
The danger in venture debt is not the coupon; it is what the credit agreement lets the lender do when the story changes. Because there is no cash flow to covenant against, the lender relies on a minimum-liquidity covenant — a floor on the cash balance — and a material-adverse-change clause that lets it call the loan if the company’s prospects deteriorate. Both are dormant while the company is well funded and both activate at the worst possible moment: when the next round slips, cash runs low, and the equity market has cooled.
That is the asymmetry students should understand. Venture debt is the cheapest money on the cap table while everything is going to plan and the most dangerous the instant it is not, because repayment was always premised on an equity round that is no longer guaranteed. The 2023 failure of Silicon Valley Bank — for two decades the dominant venture lender — was a lesson in how concentrated and correlated that risk had become: the same shock that closed the funding market threatened the lender and the borrowers at once. A venture debt facility is a bet that the equity window stays open, written by a lender who has protected itself for the case where it does not.
Where It Sits: Venture Debt vs ARR Financing vs Growth Equity
Venture debt is easiest to place by contrast with its two neighbours. Against ARR-based lending, it is earlier-stage and more judgement-driven: ARR financing is sized to a multiple of contracted recurring revenue and suits a business with predictable subscriptions, whereas venture debt is sized to the last round and suits a company whose revenue may still be immaterial. Against growth equity, it is debt — repayable, senior, minimally dilutive — where growth equity is permanent, junior and dilutive.
The warrant is what makes venture debt a hybrid rather than a pure loan, and it is worth distinguishing from other equity-linked debt. A convertible bond converts the debt itself into equity; a venture debt warrant leaves the loan intact and is repaid in cash, with the warrant sitting alongside as a separate option. Unlike PIK, which capitalises interest to preserve cash, venture debt is paid in cash from the outset — its cash relief comes from deferring repayment through an interest-only period, not from deferring interest.
The European Market: Smaller, UK-Led, and Consolidating
Venture debt is a US-born instrument, but Europe is now a serious market. European startups raised on the order of €26bn across roughly 300 venture debt deals in 2024, with debt reaching around a third of total startup funding — and the UK is the most active hub, accounting for close to a fifth of European deal volume. The specialist lenders have scaled accordingly: Kreos Capital, now part of BlackRock, reports more than $7bn committed across 800-plus transactions, with Claret Capital, Bootstrap Europe and the state-backed British Business Bank among the other active names.
For a UK or European student, the practical point is that the US on-cycle framing does not travel. The instrument is the same, but the market is smaller, more relationship-driven and less standardised than the US one, and it runs alongside a European equity market that is itself more off-cycle. Quote the mechanics with confidence; treat any single headline market figure as an approximation, because the definitional lines between venture debt, growth lending and structured financing are drawn differently by every source that counts them.
The Verdict: You Are Buying Runway, and Paying for It in Options
The mistake is to read venture debt as a loan and stop at the coupon. Priced that way it looks expensive — a low-teens rate on a company with no profits — and the analysis misses the instrument entirely. Underwritten the way the lender actually underwrites it, venture debt is a bet on the equity syndicate, sold to the borrower as runway and paid for in a warrant that costs a fraction of the equity it substitutes for. The coupon is the price of the money at risk; the warrant is the price of the upside; and the covenant is the price of the downside, payable only if the next round fails to come.
Hold those three prices apart and the instrument is clear. Venture debt is the cheapest capital a growth company can raise while it is executing and the most treacherous the moment it stops, because both the low cost and the hidden danger flow from the same fact: nobody is underwriting the business, they are underwriting the belief that someone else will fund it next. Understand that, and you understand why the warrant — not the coupon — is where the deal lives.
How It Is Tested in Interviews
The question is usually “why would a lender make an unsecured loan to a company that is losing money?” The weak answer talks about the high interest rate. The strong answer names the real underwriting — the loan is sized off the last equity round and repaid out of the next one, so the lender is underwriting the sponsor and the runway, not the cash flow — and then explains that the interest rate is not the return. The return is the warrant coverage, 5-20% of the loan, which is what compensates the lender for a portfolio that will inevitably see some defaults. Close by placing it against equity: cheaper and far less dilutive, but repayable, and lethal if the next round does not arrive.
Take Your Preparation Further
For the closest cousin to venture debt, see Recurring-Revenue Loans and ARR Financing, and for the equity alternative it competes with, Growth Equity vs Buyout. For the other equity-linked instruments it is often confused with, see Convertible Bonds and PIK: Payment in Kind. For how growth-company economics are actually measured, see SaaS and Software LBO Metrics.
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Frequently asked questions
What is venture debt and how does it work?
Venture debt is a term loan made to a venture-backed, usually loss-making growth company, provided alongside or shortly after an equity round. Because the company has no profits to service the loan and no meaningful assets to secure it, the lender does not underwrite cash flow or collateral in the normal way — it underwrites the quality of the equity investors behind the company and the runway to the next round, on the expectation that the loan will be repaid out of that next equity raise rather than out of operating cash flow. The facility is typically sized at around 25-30% of the last equity round, carries an interest-only period before amortisation, and is repaid over roughly two to four years.
How much does venture debt cost?
The coupon is a floating rate — a base rate such as SOFR or the Bank of England base rate plus a margin of roughly 6-9% — landing all-in around 8-15% in the current environment, and above 20% for the riskiest names. On top of that sit an arrangement fee of about 1% at closing and an end-of-term fee of roughly 2-3% of principal at repayment. But the largest cost is not in the rate: the lender also takes warrant coverage of 5-20% of the loan amount, the right to buy equity at the last round’s price. To the borrower that warrant costs roughly 1-3% of equity in dilution, far less than the 15-25% an equivalent equity raise would cost.
Why do venture debt lenders take warrants?
Because the interest rate alone does not compensate for the risk. Venture debt lends to cash-burning startups with a meaningful default rate, and a single-digit default rate across a portfolio would wipe out a low-teens coupon — so the coupon is essentially payment for the money at risk, not a profit. The warrant, giving the lender the right to buy shares at the last round’s price, is where the return actually comes from: on the deals that succeed, that option can turn a low-teens coupon into a high-teens or better blended return, which is what makes lending unsecured to unprofitable companies rational in the first place.
What is the difference between venture debt and growth equity?
Venture debt is a repayable, senior, minimally dilutive loan; growth equity is permanent, junior, non-repayable capital bought with a large slice of ownership. Raising £10M of equity at a £40M pre-money valuation hands over 20% of the company, whereas raising the same £10M as venture debt costs only the warrant — roughly 1-3% of equity — plus interest repaid in cash. The trade-off is risk: venture debt must be repaid on a schedule whether or not the company hits its milestones, so it is cheaper and less dilutive precisely because it is more dangerous for the borrower. The two are complements, not substitutes — venture debt is only available to companies that also have equity backing.
Is venture debt risky for startups?
The risk is real but time-shifted. While a company is well funded, venture debt is the cheapest money on its cap table. The danger sits in the covenants: with no cash flow to covenant against, lenders rely on a minimum-liquidity covenant and a material-adverse-change clause, both of which are dormant while the company is funded and activate at the worst moment — when the next equity round slips, cash runs low and the funding market has cooled. Because repayment was always premised on a next round that is no longer guaranteed, venture debt can become the most dangerous liability on the balance sheet exactly when the company can least afford it. The 2023 collapse of Silicon Valley Bank illustrated how concentrated and correlated that risk had become.