You did it. After weeks of pitches and conversations, a venture debt term sheet just landed in your inbox. This is a huge milestone, offering the fuel you need to scale your company without significant dilution.
But before you sign, it’s important to understand what you’re agreeing to. A term sheet is the blueprint for your partnership with a lender, and getting the details right protects your company, your equity, and your control.
This guide breaks down each section of a standard venture debt term sheet in simple, direct language.
What’s in a Venture Debt Term Sheet?
A term sheet outlines the key business terms of a proposed loan. While most of it is non-binding, think of it as a firm handshake that sets the stage for the final legal documents.
Once you sign, you enter an exclusivity period, so it’s your best chance to negotiate. Pay close attention to these key sections:
The Core Financials
This is the money: how much you get, what it costs, and when you pay it back.
- Amount: The total loan amount, shown as a fixed number (e.g., "$5 million") or a range. The final number is confirmed during due diligence.
- Structure: This defines the loan’s priority. Most venture debt is senior debt, meaning the lender is first in line to be repaid if the company faces financial trouble. Sometimes, it can be junior to a primary bank loan.
- Interest Rate: This is the cost of the capital. For a $1 million loan with a 15% interest rate, you would pay $150,000 in interest over a year, or $12,500 each month. Rates vary based on the market and your company’s risk profile.
- Payment-in-Kind (PIK) Interest: Some lenders offer a PIK option, where instead of paying all the interest in cash each month, a portion is added back to the principal. This lowers your monthly cash burn but means you’ll owe more at the end of the term. It’s a useful tool for preserving cash in the short term.
How will you repay the loan?
Your repayment structure significantly impacts your cash flow. You’ll typically see one of two models:
- Amortizing Loans: You repay the loan principal in installments over the life of the loan, alongside interest. This creates predictable monthly payments.
- Non-Amortizing (“Bullet”) Loans: You only pay interest each month. The entire principal is due in a single “bullet” payment at the end of the term. This model is common for startups because it maximizes cash available for growth.
Other key terms include:
- Maturity Date: This is the date the loan ends and all principal is due. A typical term is 24–36 months, giving you enough runway to hit key milestones before needing to repay the full amount.
- Early Prepayment: If you want to repay the loan early (for example, after a large equity round), you may face a prepayment fee. The term sheet will specify this cost, which usually declines over time.
What About Warrants and Dilution?
Warrants are a common feature of venture debt, giving the lender the right (but not the obligation) to buy a small amount of company stock in the future.
This is how lenders share in your upside success, balancing the risk they take. It’s important to understand that warrants are not free equity; the lender must still pay for the shares at a predetermined “Strike Price."
Warrant dilution is minimal compared to an equity round. The number of shares is defined by “Warrant Coverage,” a percentage of the loan amount. For a $1 million loan with 10% warrant coverage, the lender gets the right to buy $100,000 worth of your company’s shares. Coverage typically ranges from 5% to 30%, depending on the deal’s risk.
An alternative is a Success Fee, a small percentage of the company’s enterprise value paid to the lender only upon a sale or IPO. This option is non-dilutive.
Your Obligations and Protections
This part of the term sheet outlines the rules of the road for the duration of the loan.
- Security: To secure the loan, lenders require collateral. This is usually handled with a General Security Agreement (GSA), which gives the lender a claim on all company assets if you default.
- Negative Covenants: These are actions you agree not to take without the lender’s permission. Common examples include taking on more debt, selling major assets, or changing the business structure. Covenants are standard practice and are designed to protect the lender’s investment.
- Key Employee Commitment: The lender is betting on you and your team. This clause ensures that key founders or executives remain actively involved in the business.
- Information Rights: You’ll agree to provide regular financial updates, typically monthly. This helps the lender track performance and offer support if they see potential issues on the horizon.
The Fine Print: Fees, Deposits, and Deadlines
These final items are legally binding and finalize the process.
- Deposit: A small, refundable deposit is often required when you sign the term sheet. It shows you’re serious and is usually returned (minus legal costs) if the lender backs out. You forfeit the deposit if you walk away from the deal.
- Expenses & Setup Fee: Borrowers typically cover the lender’s legal fees for drafting documents. A one-time setup fee (1–2% of the loan) may also be charged to cover administrative costs.
- Exclusivity: This legally binding clause prevents you from shopping for other offers for a set period (usually 30–60 days) after you sign the term sheet. This is why you should negotiate terms before signing.
- Expiry Date: The offer on the table isn’t open forever. The term sheet will have an expiration date, after which the terms may change.
Founder FAQs
1. How do interest-only and amortizing payments affect my runway?
Interest-only payments keep monthly costs low, freeing up more cash for growth and extending your runway. The trade-off is a large lump-sum repayment at the end, so you’ll need a clear plan, like an equity raise or major revenue milestone, to cover it. Amortizing payments start paying down principal right away, which shortens your runway but reduces total interest costs and can make the lender more comfortable with the deal.
2. How much equity dilution do warrants actually cause?
Very little. Unlike an equity round that might dilute existing shareholders by 20% or more, warrants typically result in 1-2% dilution, and only if they are exercised.
3. What are red flags in covenants?
Red flags include covenants that give the lender too much operational control, such as approval rights over hiring, pricing, or product changes. Watch out for aggressive financial ratio requirements that don’t match your growth plan. These can limit flexibility, create unnecessary risk, and make it harder to scale.
