There’s a right time and a wrong time for venture debt. Everyone will tell you it’s a great “runway extender”, in that you can lock it in now and pull it down when you need more money to get to profitability or to your next round of funding. That can certainly be true. But there are significant risks involved and if you don’t think about these up front your venture debt can be more of a trap than a helping hand.
After you close a round of financing as a private company the question will frequently be asked, “should we extend this equity with some venture debt? Everyone knows the time to raise money is when you don’t need it, and just after closing a financing round is when you need it least, your balance sheet looks strongest, and you have new best friends willing to vouch for you in your latest VCs (the folks who just funded you). And that last point is what the debt providers will be counting on when they give you a term sheet. If a VC they trust is in your deal, the debt provider will call them and put a lot of weight on how strongly they back you. They are betting on that VC backstopping you in case things go badly as much as they are betting on your ability to fund the cash flow needed to repay the loan.
There is only one reason I can think that you would want to take venture debt: things are going great and you want more runway before you raise your next round to get a higher valuation and reduce dilution. If you are pulling it down just to survive, or because you hope your company finds its way before the next round, you are in for trouble. If things are dicey for you now, they will certainly be worse once you have fully-amortizing payments to make on a loan.
Remember that if you are fully equity funded you can always blow up most of your current burn rate and “pivot” or start over with very little cash coming in. However, if you have payments to make on a loan, you can’t just restructure. You have to keep on going at whatever rate you think is sufficient to produce revenue to pay off your loan (and obviously you are already having trouble with that or you wouldn’t be having this conversation). Or you have to be making enough progress to land your next round of capital. But if things are less than excellent you will find that loan to be like a lead weight around your neck. Once you mention it in a fundraising process you won’t be able to get away from it. Investors like their money to buy forward momentum, not pay off old debts.
As attractive as it sounds to add more money to what you just raised, you should think really hard before pursuing venture debt as it could tank your company at a critical point instead of provide the helping hand you thought you were getting.
