Negotiating the Venture Debt Term Sheet

Now that you’ve decided that borrowing money is a better option than doing an equity round, how do you determine the terms of the loan? Venture debt lenders will typically present you with a term sheet so you can evaluate their proposed deal. Negotiating a term sheet is faster, cheaper, and more effective than negotiating the loan agreements themselves, so assuming you will be working with a lawyer on the loan, you should consult your lawyer to help you negotiate the term sheet. Understanding the term sheet is important. The loan documents are merely elaborate manifestations of what the parties have agreed in the term sheet stage. Find below some key concepts you should understand before executing the term sheet.

Key Concepts in Venture Debt Term Sheets

1. Type of Loan. Are you considering a term loan, a revolving line of credit or a combination of the two? What should the maturity date be? What is the rate of interest?

2. Assets securing the loan. Will the loan be secured by all the company’s assets? Will intellectual property be excluded? If so, will the lender require a negative pledge on the intellectual property? A negative pledge is a promise not to let any other lender obtain a security interest in an asset.

3. Other Liens and Debt. Is your company free of other liens or debt on its assets? You can make sure by conducting an inexpensive lien search. Is the proposed loan permissible under the company’s material agreements or outstanding debts? If other lenders have liens against company assets, will they agree to subordinate their interest to the new lender?

4. Banking with the Lender. Is the lender requiring that you move all the company’s banking services over to them? If so, what is the account transfer period?

5. Amount of Money and When is it Provided. How much money will you need? Is the lender agreeing to provide the entire loan amount at closing or parceled out in tranches? If in tranches, what are the triggering events for additional funds – raising a specified amount of equity capital, regulatory approval, the clearance or acquisition of IP, or developing a certain product? Are there any criteria to be met for additional monetary advances within a tranche? What are the time periods for completing the triggering events? Are the triggering events realistic goals the company can accomplish within the stated time period? Many companies prefer not to borrow all of the money immediately to avoid paying interest during periods when they do not need the funds. If that is a concern, how long will the lender allow you to wait before deciding whether you actually intend to borrow funds?

6. Other Fees. Are there prepayment penalties for paying off the loan early? Are there exit fees at the conclusion of the loan period? Are any fees waived if you refinance with the same lender?

7. Default Rate and Events of Default. Does the interest rate increase if you go into default? What events or actions by the company will trigger an event of default?

8. Warrants. Is the lender asking for a warrant? How is the warrant conversion determined? What type (common or preferred) and number of shares will the lender receive upon exercise of the warrant? Is the number of shares based on the amount of the loan actually drawn at closing or the entire available loan facility? What is the warrant exercise price? When will the warrant expire? Do the warrants terminate upon an IPO, merger or acquisition?

Understanding and negotiating these issues at the term sheet stage can often lead to loan documents that better serve the company’s needs, and at a lower cost.  Our best advice in almost all cases is to get a competing term sheet. A prospective lender will always do better if it knows someone else wants your business.