Ming Li is busy.
As Silicon Valley Bank’s Regional Market Manager for Washington and Western Canada, he helps entrepreneurs access a variety of lines of credit. And last year, he was flooded with new clients as venture capitalists curtailed investment in response to the economic downturn.
“We’re seeing speeds similar to what we’ve seen in the last decade,” says Le.
As it becomes increasingly difficult to raise money through traditional venture capital, many startup advisors are urging founders to look to alternative financing tools such as venture debt and revolver loans as a way to secure cash and avoid acquiring equity. I’m telling you to look for
At a Perkins Coie event in Seattle in October, Tyler Churchill, principal of Bonfire Ventures, said his firm has been asking what a venture debt facility would look like for almost every company it invests in. He said he was advising them to consider
Startup advisors point to multiple benefits of debt. Extend cash runway without dilution, maintain ownership control, and avoid potential down-rounds when companies raise cash at lower valuations than previous rounds.
But debt has its own set of caveats. These include increased financial oversight, strict guardrails for growth and spending, and obligations to repay loan principal.
Still, many start-ups didn’t even consider debt when the stock market was in a frenzy a year ago, said Zachary Höhne, a commercial banker at JP Morgan who specializes in technology companies.
The second quarter of last year was the second-largest total venture debt in the last decade, according to PitchBook data. By the end of 2021, 2,188 deals had raised more than $29 billion, according to his Venture-Monitor report for PitchBook, with technology debt deals surpassing his 2021 figures.
Lighter Capital, a Seattle lender that provides revenue-based debt instruments to early-stage startups, doubled its book size in 2022, marking its biggest year ever, CEO Melissa Widner said. increase. She noted that Lighter is going down the traditional venture capital path, funding more companies that don’t want to risk a flat or down round.
With the cooling of the VC market, the debt of venture companies raised has increased. Venture-backed firms raised a total of $209 billion last year, down 36% from the previous year, according to funding analysis from Ernst & Young.
PitchBook analysts expect the upward trend to continue in 2023. The stock market will continue to be tough, they wrote, prompting many startups to “consider venture debt as a way to supplement their equity financing needs.”
SVB’s Le said underperforming public tech stocks could also be a factor in the renewed interest in fixed income.
Many startups have raised in previous equity rounds and boosted valuations when revenue multiples were high relative to the market. In the current down market, startups are likely valuing at the same price or even lower, which could result in a flat or down round.
Startups are often advised to avoid these scenarios because they can mean dilution of founders and their employees, Le said. Financial backers must also mark down companies in their portfolios and report the markdowns to limited partners, he added.
In a falling market, Le said it could be “helpful” for the startup to raise enough debt to keep the business going and avoid potential falling rounds.
“Especially the growth stage rounds,” he added. “It’s really hard to come by them now. So pursuing debt tends to be a good option.”
In 2022, many Seattle startups are in debt, including Convoy ($100 million), Coding Dojo ($10 million), and Icertis ($150 million).
JT Garwood, founder and CEO of medical supplies marketplace Bttn, said his company receives a revolving line of credit from Silicon Valley Bank. The debentures will help cover inventory costs and will use the company’s accounts receivable as collateral, he said.
“We had to make sure we weren’t using the venture capital that would normally be used to grow our business to buy inventory,” he said. Bttn said he received $20 million from equity investors Tiger Global and others in June.
Taking on the debt has made Bttn more financially tight, Garwood said. Lenders require quarterly audits, so startups need to know when customers will pay for their purchases. In some ways, he said, this has changed the course of business checkouts and sales.
“That’s not the downside,” he said of the added financial guardrails. “But we need to invest in resources that can provide that level of monthly quarterly reporting.”
A commercial banker, Höhne said another potential downside to taking out debt is the legal contracts that come with bank loans. He said these could include annual growth, maximum burn or minimum cash balance requirements.
These circumstances can also force founders to change their mindset, forcing them to take a more conservative approach to business growth.
Debt vehicles are usually only available to companies that have raised equity in the past and have had some success, making it difficult for new or less established startups to access this type of funding. says Hoene.
According to PitchBook, by 2022, more than 40% of all debt put into venture-backed companies will go to growth-stage startups.
Venture debt deals are often around 20-30% of the amount a startup has raised in a recent equity round. They are similar to a kind of insurance, providing just in case funds in case it becomes difficult or impossible to raise cash elsewhere, Hoene said. .
“It’s much harder for banks to get into any kind of venture debt facility when the runway is less than four months,” Hoene said, adding that the legal process to complete the terms will take months. I added that it is possible.
Venture debt lenders make their profits by charging interest, origination fees, or upfront penalties. They often have higher interest rates and shorter repayment terms (12-24 months) than traditional loans.