Warrants give the right to buy shares at a set price. Venture debt is a loan that ranks ahead of equity and often comes with warrants. In a poor outcome, the order of claims decides who recovers anything.
11 min read · Level 3
I would rather understand exactly what I receive in a disappointing sale than exactly what I receive in a spectacular one, because the disappointing sale is far more likely. Instruments are easy to compare on their upside and surprisingly different on their downside, and the downside is where early-stage investments are usually decided.
Warrants. A warrant gives the right to buy a set number of shares at a set price before an expiry date. A lender might receive warrants to buy 50,000 shares at 1.00. If the shares are later worth 3.00, the warrants are worth 50,000 x (3.00 - 1.00) = 100,000.
Venture debt. Some startups borrow from specialist lenders, usually after raising equity. A 2,000,000 loan at 12% interest costs 240,000 a year, often with warrants attached and covenants attached. It ranks ahead of all equity.
The bad outcome. A company has 2,000,000 of venture debt and 4,000,000 of preferred shares with a 1x preference, and is sold for 3,000,000:
Claim Amount owed Receives Venture debt 2,000,000 2,000,000 Preferred (1x preference) 4,000,000 1,000,000 Common (founders, angels) - 0
The order of claims, not ownership percentages, decides the result.
A summary of where each instrument usually sits:
Instrument If the company does well If the company fails Venture debt repaid, warrants may gain paid first Convertible note converts to shares creditor before conversion SAFE converts to shares per SAFE terms, behind debt Preferred shares converts or takes preference paid after debt Common shares residual gain paid last, often nothing
Because investors often focus on upside mechanics - caps, discounts, valuations - and spend less time on what each instrument does when things go wrong, which is the more common outcome in early-stage investing.
Venture debt is also easy to overlook on a cap table. It is not ownership, but it can take a large share of proceeds in a disappointing sale.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Same company, same 3,000,000 sale, without venture debt. The preferred holders take the full 3,000,000 against their 4,000,000 preference. Common still receives nothing.
With a 10,000,000 sale and the debt in place. Debt takes 2,000,000, leaving 8,000,000. If preferred investors own 40% as-converted, they choose between their 4,000,000 preference and 40% of the remaining 8,000,000 (3,200,000). They take the preference of 4,000,000. Common holders share the remaining 4,000,000.
The debt reduced common holders' proceeds in both cases, even though it holds no shares.
Evaluating a private investment by ownership percentage and conversion terms alone, without mapping the full order of claims in a poor outcome.
Include venture debt, other loans, notes, SAFEs and preferred preferences.
Calculate what each class receives at sale prices below total capital raised.
Note the strike price, number of shares and expiry, and include them in fully diluted counts.
When evaluating any private company with multiple instruments, especially one carrying debt.
Do not treat the summary table as universal. Each instrument's actual ranking and terms are set by its documents and local law.
When Silicon Valley Bank failed in March 2023, reporting highlighted how widely startups had relied on it for deposits and venture debt, and how debt facilities, covenants and lender relationships affected companies' options during the crisis.
A company's debt terms and lender become central in a crisis. Check them during diligence, not after.
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