Venture Debt: Full Explanation, Sample Excel File, and Returns Calculations

Venture Debt Definition: Venture Debt is a “bridge loan” instrument used to fund startups *in between* normal, priced equity investments from venture capitalists; it results in a higher cash expense for the startups but reduced dilution in the short term, until the next funding round or exit.

Venture debt is relatively new compared with traditional forms of startup financing, such as equity investments from VC firms and even convertible notes.

It is most useful when a startup needs extra funding to make it to its next official VC round but doesn’t want to go through an extended fundraising process or incur significant dilution immediately.

For example, if the co-founders currently own 50% of the startup, maybe they need funding for the next 1 – 2 years, and they don’t want to drop to 35 – 40% ownership.

Venture debt allows them to raise enough funds for 1 – 2 years, pay cash interest over those years, and keep dilution to a manageable level, such as 0.5% or less.

Venture debt always comes after a traditional VC round and before the next VC round; lenders would never fund startups without institutional VC investment first.

Like convertible notes, venture debt (VD) has a maturity date and an attached interest rate (usually “floating” and linked to a benchmark rate).

However, unlike convertibles or SAFE Notes:

• VD is repaid in the next funding round (not converted into common shares);
• It may have an interest-only (IO) period with no principal payments, reducing the cash outflows;
• There are usually additional utilization or prepayment fees;
• And it usually includes warrants that give lenders some of the equity upside in an exit.

The potential returns on venture debt are higher than on standard corporate bonds because of the higher interest rates and warrants.

However, the default risk is also much higher because many startups fail or fail to raise another VC funding round, so the higher potential returns compensate for that risk.

Here’s a sample Excel file and a written version of the video tutorial above:

Files & Resources:

Cap Table with Venture Debt Included (XL)

Venture Debt Tutorial – Presentation Slides (PDF)

Video Table of Contents:

• 0:00: Introduction
• 1:20: Part 1: Venture Debt: The Short Version
• 3:35: Part 2: How Lenders Earn Returns with Venture Debt
• 5:35: Part 3: Venture Debt and the Cap Table
• 6:43: Part 4: Excel Example of Venture Debt Returns
• 13:40: Part 5: More Advanced Nuances in Cap Tables
• 14:20: Recap and Summary

How Do Lenders Earn Returns with Venture Debt?

With venture debt, returns come from 3 main sources:

1) Interest – The interest rates tend to be higher than on traditional bank loans because startups are much riskier. Interest is almost always paid in cash (and if not, PIK Interest is equivalent from a returns perspective).

The interest-only period also helps because it allows lenders to earn interest on a higher principal amount in the early years.

2) Fees – As with standard debt, there are usually loan draw or utilization fees and a prepayment penalty fee if the VD is repaid before the official maturity date.

These fees might be between 0.5% and 2.0% of the principal, so they boost the returns modestly.

3) Warrants – Venture debt lenders also get warrants, similar to options, allowing them to capture some of the upside if the company is sold.

These warrants typically represent well below 1% of the fully diluted share count (e.g., 0.1% or 0.2%), and the exercise price is based on the share price in one of the surrounding VC rounds.

Lenders always want the share price from the previous round, so they pay less to exercise the warrants if there’s an exit.

Here’s an example of the venture debt terms used in this model:

When calculating the returns to venture lenders, you must include all these factors.

The initial loan issuance represents the upfront investment and is shown with a negative, while the interest, principal repayments, maturity/exit repayment, prepayment penalty fees, loan utilization fees, and warrants all represent cash inflows.

The trickiest part of this process is getting the warrant math correct because the warrants are often cashed out years into the future and require an extended timeline to forecast.

You can see a simple returns calculations below:

How Venture Debt Affects the Capitalization Table

Aside from the small number of warrants granted, there is almost no cap table impact from venture debt.

However, since these warrants are only ~0.1% of the fully diluted shares, they create negligible dilution next to traditional VC rounds.

Even when the venture debt is repaid, that doesn’t affect the cap table – it simply reduces the company’s Cash balance and may affect the eventual exit calculations.

You can see an example of the cap table impact immediately after a venture debt round below:

How to Calculate the Returns on Venture Debt: Simple Example

To calculate the returns here, we’ll make a few simple assumptions about the venture debt used to fund this startup, which is raised between its Series A and B rounds.

After the Series B round, we’ll assume an exit via a sale to another company.

Here’s a description of each round and the exit:

• Series A Round: $5 million investment at a $15 million pre-money valuation; done in Year 1 with a 10% employee options pool and a 1x liquidation preference.
• Venture Debt Round: $2.5 million investment in Year 2 with a 1-year interest-only period, 3 years of amortization, an interest rate of SOFR + 7.0%, a 2.0% prepayment penalty fee, a 0.5% loan draw fee, and 0.1% warrant coverage with exercise price based on the Series A share price.

SOFR is the “Secured Overnight Financing Rate,” a common benchmark interest rate similar to the 10-year U.S. Treasury yield.

• Series B Round: $15 million investment at a $50 million pre-money valuation; done in Year 5 with an upsized 20% employee options pool and a 1x liquidation preference. The proceeds repay the remaining venture debt.
• Exit: $200 million Exit Equity Value in Year 8.

We’d start this exercise by setting up the full cap table, including the exit calculations, to establish each party’s ownership at the end.

For more on this one, please see our capitalization table tutorial.

When the exit takes place, the option and warrant holders pay to exercise their options or warrants, which increases the available proceeds:

The Series A and B investors get paid first, and the remaining proceeds are split up between the employee option holders, the venture debt investors, and the co-founders:

With the venture debt, the first step is to track the issuances and repayments in a simple schedule, factoring in the issuance date, the interest-only period, and the repayment in the Series B round.

Most of these are simple “date check” formulas:

The principal repayment one is slightly more complex because the principal is repaid after the interest-only period but on or before the maturity, and we never want to repay more than the remaining principal in the year:

Next, you can set up the net cash flows and show the venture debt issuance as the “upfront investment,” with the interest, fees, and principal repayments all as cash inflows:

The prepayment penalty fees and draw fees are simple date checks, and for the net warrant proceeds, if we’re on the exit date, we retrieve the number from the exit analysis.

Remember to subtract the amount the venture lenders pay to exercise their warrants!

The internal rate of return (IRR) and multiple of invested capital (MOIC) here are 12.4% and 1.4x, respectively, which matches our expectations.

The average interest rate in the period is 10 – 11%, and the fees and warrants boost the IRR slightly above that level.

It would be exceptionally unusual if they boosted the IRR to 20% or 30%.

More Advanced Treatment of Venture Debt in the Flow of Funds and Cap Table Analysis

Of course, there are many more complexities to venture debt:

• You should determine the exercise of the warrants and options “the right way” by calculating the implied share price in the exit and comparing it to the respective exercise prices. This creates circular references and other Excel issues.
• You should analyze different scenarios, such as when one investor group converts their preferred shares into common shares and others do not.
• You should also factor in participating preferred and participation caps for the VC investors, which will affect the equity proceeds.
• You should account for options that are vested and exercisable ones that are not, as this difference can significantly affect the proceeds to each group.

We cover these more advanced nuances (and more) in our full Venture Capital & Growth Equity Modeling course in the Advanced Cap Table case study there.