Capital Strategy Memo: Venture Debt vs Convertible Notes in a 6% Rate World

After two years of rate hikes, the effective cost of capital still sits well above prepandemic levels. Founders raising bridge capital in late 2025 must decide whether to lean on venture debt, structured convertibles, or a mix of both before aiming for a 2026 growth round or IPO. This memo summarizes current market terms, provides a modeling framework, and offers decision criteria for mid to late-stage SaaS and AI companies.

Executive Summary

• Base rates stabilized near 6 percent in the US and UK. Lenders price venture debt at SOFR plus 400 to 500 basis points, pushing all-in rates to 10 to 11 percent.
• Convertible notes regained popularity. Investors ask for valuation caps 15 to 25 percent above the last preferred round with 5 to 10 percent discounts at conversion.
• Stacked instruments are common. Growth companies blend modest debt lines with convertibles to extend runway without telegraphing down rounds.
• Decision hinges on metrics. Companies with Rule of 40 above 30 and net retention over 120 percent can secure more favorable debt terms. Heavy-burn teams risk covenant breaches and should consider convertibles or equity instead.

Financing Instruments Overview

Venture Debt Snapshot

• Structures: Term loans (36 to 48 month amortization, 6 to 12 month interest-only periods) or delayed-draw facilities tied to milestones.
• Economics: SOFR + 450 bps average spread in Q3 2025. Warrant coverage 0.5 to 1.5 percent of fully diluted shares. Commitment or success fees 1 to 2 percent.
• Covenants: Minimum liquidity or cash burn targets, borrowing-base tests, material adverse change clauses. Reporting cadence monthly to quarterly.
• Lenders: Silicon Valley Bridge Bank, Hercules, TriplePoint, Stifel, specialty debt funds.

Convertible Notes and SAFEs (Late-Stage Flavor)

• Terms: 18 to 24 month maturity, simple interest 5 to 6 percent (often PIK), valuation caps 1.2 to 1.5 times last preferred round, 5 to 10 percent discount at conversion.
• Investor mix: Existing insiders, crossover funds, strategic investors, and opportunistic hedge funds.
• Protective provisions: Most notes add MFN (most favored nation) clauses, pro rata rights, and information rights.
• Accounting: Treated as equity-like; no immediate impact on debt ratios but may dilute more if the next round prices below the cap.

Comparative Financial Modeling

Model a base scenario to understand dilution versus cash interest. The sample below assumes a Series C SaaS company with USD 50M ARR, 65 percent gross margin, 20 percent growth, and USD 6M quarterly burn.

Sensitivity checks:

• If revenue growth dips to 12 percent, debt covenants breach in month 10. Convertible notes absorb the shock but convert at a lower valuation, lifting dilution to 3.1 percent.
• If Series D prices at USD 700M (down round), notes convert at cap with full discount, diluting 3.7 percent. Debt continues to amortize; warrants may represent cheaper dilution.

Operational Considerations

• Cash runway: Debt extends runway with minimal dilution but requires clear path to profitability. Convertibles provide flexibility but may push dilution to a future financing event.
• Signal to market: Venture debt signals lender confidence if metrics support it. A large convertible can imply a bridge toward a structured equity round.
• Reporting load: Debt demands monthly reporting, board compliance updates, and potentially audited statements. Convertibles usually require quarterly updates but fewer operational covenants.
• Board dynamics: Debt may require board approval for negative covenants. Convertibles might need investor consent if they change liquidation preferences at conversion.
• Talent and customer perception: Communicate financing strategy to key employees and enterprise accounts to avoid questions about runway stability.

Decision Framework

Use this checklist to pick the right mix:

• Performance metrics: Are gross margins above 60 percent, net retention over 115 percent, and burn multiple under 1.5x? If yes, debt becomes viable.
• Predictability: Do you have clear ARR forecasting and low churn? Debt covenants rely on accurate projections.
• Collateral: Can you pledge IP, accounts receivable, or cash? Lenders expect security interests, though many accept a lien on IP plus cash covenants.
• Investor appetite: Will insiders or strategics participate in a note? If not, debt may be the only realistic option without repricing.
• Exit timing: If IPO or strategic exit is 12 to 18 months away, use debt or a short-term note to bridge, then refinance in public markets.

Action Plan (Weeks 1 to 6)

Mix and Match Tactics

• Stagger drawdowns. Use a USD 10M venture debt facility with staged availability tied to ARR milestones; pair with a USD 10M convertible now to lock cash while you ramp ARR.
• Refinance on milestones. Convert short-term notes into a new priced round within 12 months to avoid maturity cliffs.
• Co-investor alignment. Offer MFN provisions to early convertible investors but cap them when a priced round launches to prevent overhang.
• Protect runway. Set aside at least three quarters of interest and amortization payments in treasury forecasts before signing.

Sources and Further Reading

• SVB: Venture Debt Market Outlook 2025
• Cooley: 2025 Venture Financing Report
• Kruze Consulting: Startup Loan Benchmarking 2025