Brian Nichols is the co-founder of Angel Squad, a community where you’ll learn how to angel invest and get a chance to invest as little as $1k into Hustle Fund's top performing early-stage startups

More startups are taking on debt than ever before. And here's the wild part: this happened while VC funding stayed flat or declined.

So what's going on? Why are startups suddenly borrowing money instead of raising equity?

The answer is simple. Raising equity got expensive. Valuations dropped since 2021, which means founders have to give away more ownership to raise the same amount of cash. For many companies, borrowing money became a cheaper way to extend runway.

But venture debt is not free money. It has to be paid back. With interest. And if you can't pay it back, bad things happen.

Time to talk about when venture debt makes sense, when it's a terrible idea, and how to evaluate whether it's right for your company.

What Venture Debt Actually Is

Venture debt is a loan, but not like a bank loan for your house.

Traditional banks want to see consistent cash flow and hard assets they can seize if you default. Startups have neither of those things. You're burning cash to grow, and your "assets" are mostly code and brand value that disappear if the company dies.

So venture debt lenders take a different approach. They lend to startups that have already raised VC money. The logic is simple: if smart investors are betting equity on this company, we can bet debt on it too. Our returns are lower than equity investors, but our risk is also lower because we get paid back first if something goes right.

The economics work like this:

You borrow, say, $2M. You pay interest (usually 8-12% annually). You make monthly or quarterly payments. At the end of the term (typically 3-4 years), you pay back the principal. The lender also usually gets warrants (options to buy equity at a set price), which gives them upside if the company does really well.

Unlike equity, where you're giving away ownership forever, debt eventually goes away. You pay it off and you're done. That's the appeal.

The catch is you have to actually pay it off. And if you're still burning cash when the payments start, you're in trouble.

When Venture Debt Makes Sense

Despite the risks, there are scenarios where venture debt is legitimately smart:

You're growing fast and need a bridge to the next milestone. Let's say you're six months away from hitting $2M ARR, which will unlock your Series A at a much better valuation. You've got $300K in the bank and you're burning $100K/month. You can either raise an emergency bridge round at a flat or down valuation, or you can borrow $500K to extend your runway. The debt is cheaper than the equity dilution.

Elizabeth Yin, co-founder and general partner at Hustle Fund, breaks down the thinking: "In general, you want to take equity when things are quite risky and not guaranteed of working. And you want to take debt when you just need working capital but it's a near-slam dunk you are going to be able to use money to make money immediately."

You have a high-performing growth channel and want to invest more without raising equity. Maybe your paid acquisition is working incredibly well and every dollar you put in generates $3 in LTV. Borrowing money to fuel that engine makes total sense because you know you'll generate the cash flow to pay it back.

You just raised equity and want extra cushion. VCs sometimes suggest taking venture debt right after closing an equity round. You're not desperate for cash, but an extra $1M-$2M of debt capital gives you more breathing room to hit your milestones. And because you just raised equity, your credit risk is lower, so you can get better terms.

You're profitable or close to it and want to avoid dilution. If you're growing sustainably and generating cash, debt is almost always cheaper than equity. Why give away 10-20% of your company when you can borrow money at 10% interest and pay it back in a few years?

You need capital for a specific use case that will generate returns quickly. Buying equipment, expanding to a new market, or hiring a sales team where you know the payback period. Debt for defined, ROI-positive activities makes sense.

In all these scenarios, you're using debt as a tool to optimize your capital structure. You're not using it to cover up fundamental problems with your business.

When Venture Debt Is a Trap

Now let's talk about when venture debt goes wrong.

You're using debt to extend runway without a clear path to profitability or your next fundraise. This is the most common mistake. You're burning cash, you're not sure when you'll be profitable, and you're hoping that six more months will magically make everything better. It probably won't. You're just adding debt payments on top of your existing burn rate, which makes the situation worse.

You can't afford the monthly payments. Venture debt typically requires monthly or quarterly payments starting immediately or after a short grace period. If you're already cash-strapped, adding another $30K/month in debt service might be the thing that kills you. Do the math before you sign.

Your investors aren't supportive. Smart VCs will tell you whether venture debt makes sense for your situation. If they're saying no and you're doing it anyway, that's a red flag. Either they don't think your business can support the debt, or they're worried about your judgment.

You're using it as a band-aid for a broken business model. If your unit economics don't work, if customers are churning faster than you can replace them, if your product isn't gaining traction, debt doesn't fix any of that. It just delays the inevitable while adding more obligations.

You don't understand the terms. Some venture debt agreements have covenants (rules you have to follow) that can be restrictive. Maybe you have to maintain a minimum cash balance. Maybe you can't raise more money without the lender's approval. Maybe they have the right to convert debt to equity at a down round valuation if things go south. Read the fine print.

The fundamental question is: will the business generate enough cash flow to pay back this debt, or are you just buying time?

If you're buying time and you don't have a concrete plan for how things will improve, venture debt is probably a mistake.

Who's Actually Lending (And What They Want)

The venture debt market changed dramatically after Silicon Valley Bank collapsed in 2023. SVB was the biggest lender to startups, and when they went down, a huge gap opened up (but they eventually restarted lending!).

New players rushed in to fill it. Private equity firms, alternative lenders, and non-bank financiers all started offering venture debt. The market is more competitive now, which is good for founders. More lenders means better terms and more options.

Lenders are looking for a few key things:

You've raised at least one round of institutional capital. They want to see that smart VCs have bet on you. That's their signal that you're worth lending to.

You have revenue or clear path to revenue. Lenders are more comfortable with B2B SaaS companies that have predictable recurring revenue than, say, a social app with lots of users but no business model. 

Your financial metrics are solid. They'll scrutinize your burn rate, growth rate, cash runway, and unit economics. If the numbers don't make sense, you won't get favorable terms (or any terms at all).

Different lenders have different appetites for risk, different fee structures, and different requirements. Shop around. Talk to multiple lenders. Compare terms.

The Hidden Costs

Interest and warrants are obvious costs, but there are others:

Covenants and restrictions. Some lenders require you to maintain certain financial metrics. If you violate those covenants, they can accelerate the loan (demand immediate repayment) or impose penalties.

Time and distraction. Negotiating a venture debt deal takes time. Legal fees. Diligence. Paperwork. That's time you're not spending building your product or talking to customers.

Mental burden. Debt creates pressure. You know you have to pay it back. Every month, money flows out of your bank account. For some founders, this pressure is motivating. For others, it's stressful in a way that equity isn't.

Reduced flexibility. If things go sideways and you need to pivot, having debt payments hanging over your head constrains your options. You can't just burn less cash without also figuring out how to make your debt payments.

Make sure you're okay with these tradeoffs before you take on debt.

What VCs Think About Venture Debt

Most VCs are fine with venture debt if it's used strategically. They might even suggest it.

But they hate it when founders use debt as a desperate move to avoid a difficult conversation about the business. If you're struggling to raise equity and you turn to debt as a last resort, that's usually a bad sign.

VCs understand that debt doesn't change the fundamentals of your business. If your growth is slowing, your churn is increasing, or your unit economics are broken, debt just delays dealing with those problems.

On the other hand, if you're crushing it and you want to extend runway or invest in growth without diluting, VCs love that. It shows discipline. It shows you understand how to optimize your capital structure.

When in doubt, talk to your investors before taking on debt. Get their perspective. They've seen this movie before.

Should You Take Venture Debt?

My framework for deciding:

If you're pre-product-market fit: Probably not. You don't know if your business model works yet. Adding fixed costs in the form of debt payments is risky.

If you're post-product-market fit but pre-profitability: Maybe. It depends on how confident you are in your growth trajectory and your ability to raise equity later.

If you're profitable or close to it: Probably yes. Debt is almost always cheaper than equity if you can afford to pay it back.

If you're desperate: No. Debt doesn't fix a broken business. It just makes the problems more expensive.

Talk to your investors. Model out the cash flows. Understand exactly what you're signing up for. Make sure the terms make sense and the timing is right.

And if you want to learn how other founders have navigated these decisions, Angel Squad is full of people who've been through this. We've seen venture debt save companies and we've seen it kill companies. We'll help you figure out which category you're likely to fall into. Because the difference between smart leverage and a debt spiral is really just about understanding your own business and being honest about what's possible.

Venture debt is a powerful tool. Just make sure you're using it to build something, not to delay the inevitable.