Prepayment penalty is a contractual charge triggered when a borrower retires loan principal before maturity—protecting lenders’ expected yield on venture debt, term loans, and some private credit facilities.

How it works

Penalties vary: fixed percentages of outstanding principal (e.g., 1–3% in year one, stepping down), make-whole provisions tied to foregone interest, or prepayment premiums on subordinated notes. Venture debt agreements disclose penalties in term sheets; founders should model payoff at next equity event including fees and any end-of-term warrants.

Refinancing to cheaper capital may still make sense after penalty math. Acquisitions often require debt payoff at close—buyers negotiate who bears penalties and whether they adjust purchase price.

Why it matters

• Founders: Surprise penalties shrink net proceeds from a raise earmarked for debt cleanup—read loan covenants before signing.
• Investors: Diligence includes debt schedules; penalties affect effective enterprise value and cash-free debt-free mechanics.

Common mistake

Assuming friendly venture lenders waive penalties informally at payoff—get waiver or payoff quotes in writing before wiring.

Related ideas

See venture debt, call protection, and event of default.