Drop The Sponsor
- Xavier Van Hove
- Feb 21
- 3 min read
Updated: Feb 24
Executive Summary
Most of the venture debt industry relies on "sponsors" when making loans - a VC firm that has invested heavily in the borrower and provides lenders with confidence in the business's prospects.
At Nighthawk, we collaborate with several VCs and appreciate seeing them on the cap table. However, we do not rely on them to sponsor deals - in fact, we prefer making "unsponsored" loans. Our lending decisions are fully independent and do not need to be tied to an equity raise.
As we discuss below, this approach offers a better deal for both founders and our investors.
Avoiding Dilution
Taking a step back, the main issue successful founders face is dilution. As you can see below, the average founders own just 12% of their business by the time they exit.
Venture debt has become an increasingly important tool to combat dilution. In the U.S., companies like Google, Facebook, Uber, Airbnb, and Dropbox all used it early on. We are now seeing European founders follow suit.
Extending the runway
Venture debt aims to extend a company’s cash runway. Let's look at DailySaaS, a theoretical example of a typical sponsored the debt issuance.
£2mm equity raised with Big VC (the sponsor)
cash burn of £100k/month
Runway before debt: 20 months
Venture debt offer: £1M, 5-year term, 14% interest
As the chart shows:
Venture Debt adds seven months of runway, but
DailySaas pays interest for the full 20 months before needing the cash
the effective interest cost for over those seven months is therefore 54% - far higher than it appears at first glance.
A Smarter Approach to Venture Debt
A better solution is to raise the debt when you need if - e.g. ahead of an equity raise to extend the cash runway. As demonstrated below, this will significantly increase the runway of the company, thanks in part to the higher valuation that can be reached on the equity raise by delaying it.
The flip side is a slightly higher interest rate (typically around 18%), but:
Interest payments only begin when the company actually needs the capital.
Once equity is raised, the debt starts amortizing, reducing long-term costs.
Early repayment is often possible with reasonable fees.
As a result, the lifetime cost of unsponsored debt can half that of sponsored debt.
A Better Deal for Investors Also
So why is this a better deal for debt investors as well? Here are the key ones you should consider if you are considering allocating money to a venture debt fund:
1. Higher Returns
Unsponsored debt commands higher interest rates and/or more favourable warrants.
2. Safer Repayments
Unsponsored debt usually has stricter break-even target requirements, meaning the companies are usually better credits in the first place.
The unsponsored lender has a clear understanding of when and from whom the borrower will raise in the next 6-12 months. In contrast, sponsored deals rely on companies finding investors in 4-5 years.
3. Eliminating Conflicts of Interest
Conflicts arise from two sources:
The hand that feeds: Sponsored lenders rely on VCs to bring them deals. How willing would they be to force a down round if needed?
Internal conflicts: Some venture debt providers also have VC arms, creating misaligned incentives. Would a venture debt lender go against its own parent firm? Unsponsored lenders, being fully independent, avoid this issue.
4. Better Warrant Terms
Let's make this interactive:
Who gets better warrant terms?
The lender reliant on VCs for deals
The lender working directly with founders
5. Stronger Portfolio Selection
One more poll:
VCs introduce venture lenders to:
Their top 20% companies?
Their bottom 80%?
A venture debt lender aligned with founders can select the best deals from the entire market rather than being limited to a VC’s weaker bets.
In summary
Whether you’re a founder or an asset allocator, unsponsored venture debt offers a far better deal. Get the funding and returns you need – on your terms.
Comments