What to do when you can’t repay your venture debt?
- Communicate with your lender early and often. Create trust from the start and be open about what is going well and what is not. It gives your lender the confidence and time to problem-solve with you.
- Lenders want to be founder-friendly and find creative solutions if venture debt isn’t able to be repaid on time. Get both parties to the table to find a path forward.
- These situations are messy, but you are not alone. This happens all the time. Prioritize getting your lenders repaid, even if it means looking at alternative paths and deals.
After raising equity, venture debt is a way for startups with VC backing to fund their operations via loans from specialized banks or non-bank lenders. As opposed to venture financing, venture debt needs to be paid back to the lender. These loans can be used for a number of purposes, including capital expenses, acquisitions, as a runway extension, to face rocky market conditions and short-term issues, and as a bridge to the next round of equity.
However, what happens if a startup is not able to pay back their venture debt? When a company is over leveraged and has little cash in hand, what are their options?
We tapped into Stage Fund GP, Krista Morgan’s, expertise to learn about what happens when a company is not able to pay back their venture debt and how Stage Fund steps in to help.
Why Venture Debt?
Venture debt, as Krista described it, is essentially a line of credit for companies who have already had venture financing. It can be used to keep a cash balance in the account and to bridge the company between venture rounds. Startups who get a big financing round are typically offered venture debt at attractive terms and will often keep taking debt between rounds until the company is sold.
Venture debt can get paid back with each new round of funding or, more likely, the lender will be paid back after several rounds once the company has sold. The problem comes when you start to run out of cash and the next funding round isn’t coming together.
“Venture debt is financing that can feel like equity, until you can’t pay it back – then it feels like debt again.”
Oftentimes, startups are not able to pay back their debt because they haven’t been able to raise their next round. Their business isn’t cash flow positive and isn’t profitable enough for private equity investors to sign on for the next round. The startup is left without a clear path forward for survival and growth.
“No one talks about this, but this happens all the time,” said Krista. For founders, it can feel like an isolating experience and a career-ending error but, Krista emphasized, “it happens and it’s not the end of the world.” The team at Stage Fund has the expertise and experience to help startups in this very situation find stability and get a fresh start.
Early Founder-Lender Communication
The most important thing that founders can and should do is to be communicative with their lenders. “Any time you borrow money,” Krista added, “it’s critical to be in good communication with your lender about the situation.” As difficult as it can be to talk about tough topics, it’s important to be more open rather than less. The earlier you can communicate the status of the round, the feedback you’ve been collecting, and the reasons why a round is taking longer than expected, the better. Create trust from the start and be open about what is going well and what is not.
When you are proactive with your communication, it gives your lender the confidence and time to figure out a solution with you. For example, they could ask for principal payments to alleviate risk, offer no interest payments to give you time to raise your round, or find a new lender for refinancing.
When Venture Debt Can’t Be Paid Back
When a company isn’t able to pay back its venture debt, contract provisions kick in and it may lead to default. However, venture lenders understand the risks and know that if they enforce every default, they are less likely to get paid back. Instead, it is in their best interest to work with their founders to find a route forward to eventual repayment.
As founders representing your shareholders, it’s your job to create returns for your investors. However, if you can’t pay back your venture debt, your duty shifts. Now, your job is to get your lender paid back.
“Do what you have to do in order to make this happen. They are the most important stakeholder now, more than your venture capitalists.”
This may mean compromising and looking at deals you didn’t want initially – down round financing, exiting earlier than intended, or finding investors for the next round who would be open to a combination of debt and equity and a company restructuring. There is no one way that it happens, but it requires high levels of communication with your lender.
This is exactly where Stage steps in to help. Many founders, even multiple-time founders, have not gone through the niche process of negotiating with lenders. The team at Stage Fund have seen it all and have the operational expertise to know how to get deals done efficiently.
“It happens. Everyone involved knows the risk and you’re not the first startup team this has happened to,” said Krista. Stage Fund knows how to get people to the table to have those tough conversations and get the deals signed. “We know how lenders think. It’s better for the bank to get something over nothing and lenders want to be founder-friendly and open to creative solutions. We work with founders to show their lenders a path to repayment – without judgment, without criticism. We are problem solvers.”
These situations are messy. “Sometimes they’re fixable. Sometimes they’re not and the lender and VC lose money. Regardless, it is a learning experience for the founders and lenders.” This is where Stage lives and what they are great at solving. It speaks to one of Stage Fund’s mottos: create value out of chaos.