Reading a debt term sheet
The twenty-two terms worth negotiating, in the order they matter — which is not the order they appear in.
In brief
- Read the tranche conditions first and the margin last.
- A missed tranche condition costs more than any interest rate you could negotiate.
- Ask what the material adverse change clause has been used for.
A venture debt term sheet runs to four pages and roughly twenty-two negotiable points. Borrowers routinely negotiate two of them, and neither is usually among the five that matter most.
Read it in this order
- Conditions to the later tranches — the money you are counting on and may not get.
- The covenant package, and what a single bad quarter does to it.
- Warrant coverage and strike price.
- Prepayment protection.
- The margin.
Why the margin is last
Because it is the number every borrower anchors on and the number the lender has least room to move. A hundred basis points on a £5m facility is £50,000 a year. A tranche condition you miss removes £3m of the facility outright.
| Term | Typical ask | Worth negotiating |
|---|---|---|
| Tranche 2 revenue condition | 1.4× current ARR | Up to the whole tranche |
| Minimum ARR covenant | 85% of plan | The facility itself |
| Warrant coverage | 1.5% | Six figures at exit |
| Prepayment penalty | 3% in year one | Mid five figures |
| Interest margin | +750bps | Low five figures a year |
The clause borrowers forget
Material adverse change. It is short, it is vague, and it is the clause under which a lender declines to fund a tranche you have otherwise earned. Ask what it has been used for.
A term sheet is a description of what happens when the plan does not hold. Read it that way.
What to send back
One document, marked up, with your three priorities stated at the top and the rest accepted. A lender reading twelve scattered objections cannot tell which would lose the deal. A lender reading three cannot pretend not to know.
Continue learning
Covenants, and what breaching one actually means
The tests a lender sets, and what happens when you fail one.
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