All money is not created equal: What raising venture debt looks like

David Spreng is a seasoned venture and growth debt lender with 30 years of experience, the founder and CEO of Runway Growth Capital, and the author of All Money Is Not Created Equal.

The first step in the process of raising venture debt is a quick, introductory filtering phone call between you and the potential lender that’s an equal amount selling and listening – on both sides.

Think of it like a first date. Should that go well, it should then be followed up quickly with both parties signing an NDA. (VCs don’t like to sign NDAs, but venture debt lenders don’t have a problem with it.)

At this point, we would start our initial due diligence. We typically ask a company for six things:

An investor presentation

If you are looking for investment money, you probably have recently raised equity. The investor deck you would have used for that works for venture debt as well. (There are numerous examples online.)

The 409A

The annual valuation of the equity value of the company, designed to protect employees who are granted stock options so that they can’t later be slapped with a tax for getting “cheap stock.” Usually those valuations come in at a level that makes getting equity attractive to employees. Don’t worry if the value assigned by the 409A valuation firm is lower than what you believe is fair. We know how these valuations work and don’t become fixated on their valuation.

The 409A will include different ways of analyzing the value of the company, the same things we look at: discounted future cash flow; comparables to public companies; comparables to recent M&A. It will also give a really good history of all the funding the company’s ever gotten, and it always includes a five-year projection.

A detailed capitalization table and funding history

This will include everybody who owns any piece of the company, a history of fundraising and a history of any bank financing or external debt used.

Historical financials

Ideally, we will receive five years of historical financial statements. We would love it if they were audited, but it’s not necessary.

Projected financials

For us to do our work, we want a fully linked, three-statement financial model. The three statements are: balance sheet, income statement, and statement of cash flow. If there are delays or issues in the process, it’s usually because of a delay in getting linked three-statement projections, which allows us to do “what-if” analyses (such as: “If things go worse than planned, when do things break? How much does this startup need to reduce their variable expenses to remain viable and able to service our debt?”).

Everything I’ve outlined should take an estimated 4-5 weeks from our first phone call. That puts it at Week 6 for a signed term sheet.

Often we’re lending to companies that sell to big enterprises, so instead of having a million customers they’ve got a hundred, and we’ll want to understand how they sell, how predictable their sales forecasts are, and how comfortable they are with the coming years. All of that helps us judge how much we believe in their financial projections.

A list of the largest customers, present and past

Detailed customer information allows us to identify customer concentration or churn. Those can be quick disqualifiers, and we don’t want to waste a lot of anyone’s time if that’s the case.

If a potential borrower’s customer base is too concentrated (fewer than 15 total customers or more than 50% of revenues from just a few customers), that’s too risky for us. Or if the startup has a lot of churn – meaning that their existing customers decided they’re not going to renew or stay with them – that’s another red flag/likely disqualifier. There is nuance around this, too. If your product has evolved significantly and in what we would consider a positive, logical direction, then churn could make sense.

With all this information, we can do a desktop analysis that typically takes two weeks. We could do it more quickly if absolutely necessary, but we like to give ourselves two weeks. If the desktop analysis is positive, we would issue a term sheet.

Doing it our way allows us to customize a thoughtful structure and set of terms that are fair for us and appropriate for the borrower. For example, tailoring the loan for the borrower could be around when you actually need the money. Maybe you need it right away, or perhaps it’s a little further down the road.

Other variations could mean structuring the deal so the interest rate declines as the company gets stronger, or having a longer interest- only period, where the debt isn’t amortizing, because you wouldn’t be in a position to start to amortize until a certain event occurs.

I would estimate that everything I’ve outlined above should take about four to five weeks from our first phone call. That means you’d probably have a term sheet by Week 5.

Going to the board

Up until now you’d probably only have the CEO and CFO involved. Once you get a term sheet, you’d want to present the deal to the board.

Some companies will have their board involved from the beginning of the process. I’ve known of deals that got derailed because a board member didn’t want to do a deal with a specific lender. It could be a personal (and one-sided) beef; it could be that a board member knows something specific about the lender. This has never happened to us, which is why I suggest at least letting your board know what lenders you’re talking to early in the process.

How quickly things move from the board presentation step depends on the borrower. They’ll likely be looking over term sheets from different lenders. I would guess 10% of the time we’re the only lender involved. The other 90% of the time there are multiple lenders pitching to provide growth capital. The company may also be considering using some or all equity to meet their needs.

If there are three or four term sheets to work through and compare, you will probably take about a week to get through those. While a deal itself may be relatively straightforward, that doesn’t mean that every deal will be the same. Not only do lenders differ regarding the stage at which they will lend money, but some will also specialize by industry. Terms will, of course, vary from lender to lender.

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