Startups Venture

Debt Financing Could Heat Up As Venture Capital Slows

It’s much too soon to proclaim the demise of venture capital raises as the market seems to be in the midst of an adjustment, but debt financing seems to be popping up in the news more.

Earlier this week, corporate card and expense automation startup Ramp announced a $750 million raise at $8.1 billion—$550 million of which was debt financing backed by Citi and Goldman Sachs. Earlier this month, banking service provider Mercury announced it will launch its own venture debt offering—looking to lend more than $200 million this year and up to $1 billion over the next two years—following other fintech brethren like Brex into the debt offering realm.

Those headlines are against a backdrop of what many see as a slowdown in startup funding as geopolitical issues, public market tumult and a lingering pandemic has brought uncertainty to the market. Investors have told Crunchbase valuations are off about 20 percent or more for many startups from late last year.

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That type of decrease may explain why those in debt say things are getting busy.

“Are the conversations changing? Yes, over the last month or so,” said Dan Allred, senior market manager at Silicon Valley Bank. “The equity markets are choppy.”

What is it?

Venture debt can be defined differently even by those in the industry. Traditionally, venture debt has referred to debt a VC-backed company raised—usually in unison with raising equity—to both elongate its runway and cut down on dilution.

The debt—often less structured and with less financial covenants than other forms of debt—is used for traditional growth purposes and is often lent based on the startup’s investors and/or where the company is in its growth.

Now, with the rise of fintech companies, different kinds of asset-backed debt like “warehouse financing” have become popular. That type of debt can be secured by assets and loans those companies generate—something a typical SaaS company may lack. The debt Ramp raised has been this type.

However, all debt has the similarity of giving companies cash they may need while not diluting the stakes of founders and shareholders. And while venture debt—if raised in conjunction with equity—may not prevent a “down round” in this environment, it can lessen the amount of more expensive venture capital needed and also lower dilution.

“Obviously, the last couple of months has evolved the conversation around venture debt,” said Benjamin Wu, CEO of Brex Asset Management, which launched the company’s venture debt product last August. “But more broadly, this is something that has been around for decades … it’s a product people are better understanding.”

A fit for this market

Brex currently lends anywhere between a couple of millions of dollars and $15 million, and rates can range—depending on the company—from 4 percent to around 10 percent. Despite being in the market for less than a year, Wu said Brex’s venture debt product is nearing the $800 million mark in terms of lending to a broad array of companies from SaaS to e-commerce.

With the current state of the market, he expects that lending pace to continue.

“With the market volatility … there is strong inbound interest,” he said.

David Spreng, chairman and CEO of Runway Growth Capital, also called deal flow strong so far this year. Runway will lend to companies with no venture backing but normally looks for late-stage clients with $75 million or more in revenue.

With the current slowdown in the growth-stage rounds in venture capital, Spreng said he has no doubt debt will have a strong year.

“VCs have a lot of dry powder, but they are focusing on their ‘big winners,’” he said. “So a lot of companies may get orphaned.

“I expect a record year,” he added.

We’ve been here before

This isn’t the first time the market has faced uncertainty and interest in debt has increased.

Allred said venture debt saw significant growth in 2008 as the global financial crisis took hold. Much more recently, venture debt became very popular in March 2020 as the COVID-19 pandemic started. While it wasn’t so much companies raising debt, more startups started to use their credit facilities then as they were eager to hold on to cash and shore up their balance sheets.

“As equity capital becomes more expensive, interest in debt goes up,” Allred said.

With rising interest rates and markets that can look unstable at times, it is fair to wonder if, like equity, debt will also dry up.

“It’s true credit markets tighten when equity markets tighten,” Allred said. “But in general, debt capital … remains more open.”

While the framework around venture debt can differ—from no covenants to facilities that are more structured—it can be a viable option not just for startups looking to weather a storm but also extend their runway and the money they’ve raised.

“It’s always been a good tool against expensive equity,” he said. “It can prolong the life of that expensive equity.”

Illustration: Li-Anne Dias.

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