It is far too early to proclaim the disappearance of venture capital raises as the market seems to be in full adjustment, but debt financing seems to be in the headlines more.
Earlier this week, Ramp, the business card and expense automation startup, announced a $750 million raise to $8.1 billion, including $550 million in backed debt financing by Citi and Goldman Sachs. Earlier this month, banking services provider Mercury announced it would launch its own venture debt offering – aiming to lend more than $200 million this year and up to $1 billion over the next two months. coming years – following other fintech brothers like Brex in the debt offering space.
These headlines are set against the backdrop of what many see as a slowdown in startup funding, as geopolitical issues, public market turmoil and a lingering pandemic have sown uncertainty in the market. Investors said Crunchbase valuations have been around 20% or higher for many startups since late last year.
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This type of decrease may explain why people in debt say things are getting busy.
“Are the conversations changing? Yeah, over the last month or so,” said Dan Allred, senior market manager at Silicon Valley Bank. “Stock markets are choppy.”
What is that?
Risk debt can be defined differently, even by industry players. Traditionally, venture capital debt refers to debt that a venture capital-backed company has raised – usually in unison with raising equity – to both lengthen its runway and reduce dilution.
Debt – often less structured and with fewer financial covenants than other forms of debt – is used for traditional growth purposes and is often loaned based on the startup’s investors and/or the company’s stage of growth .
Today, with the rise of fintech companies, different types of asset-backed debt like “warehouse financing” have become popular. This type of debt may be secured by assets and loans generated by these companies, which a typical SaaS company may lack. The debt that Ramp raised was of this type.
However, all debt has the similarity of giving businesses the cash they may need without diluting founders’ and shareholders’ stakes. And while venture capital debt, if raised in conjunction with equity, does not prevent a “downside” in this environment, it can reduce the amount of costlier venture capital needed and also reduce dilution.
“Obviously, the last two months have shifted the conversation around subprime debt,” said Benjamin Wu, CEO of Brex Asset Management, which launched the company’s subprime debt product last August. “But more broadly, it’s something that’s been around for decades…it’s a product that people understand better.”
A fit for this market
Brex currently lends between a few million dollars and $15 million, and rates can vary, depending on the company, from 4% to around 10%. Although it’s been on the market for less than a year, Wu said Brex’s venture debt product is approaching the $800 million mark in terms of lending to a wide range of businesses, from SaaS to e-commerce.
With the current state of the market, he expects this pace of lending to continue.
“With the volatility in the market…there is strong inbound interest,” he said.
David Spreng, president and CEO of Runway Growth Capital, also called deal flow strong so far this year. Runway will lend to businesses without venture capital funding, but normally seeks late-stage clients with revenues of $75 million or more.
With venture capital growth phases currently slowing, Spreng said he has no doubt debt will have a strong year.
“VCs have a lot of dry powder, but they’re focused on their ‘big winners,'” he said. “So a lot of companies can become orphans.
“I expect a banner year,” he added.
We’ve been here before
This is not the first time the market has faced uncertainty and interest in debt has increased.
Allred said subprime debt grew significantly in 2008 as the global financial crisis took hold. Much more recently, venture debt became very popular in March 2020 at the start of the COVID-19 pandemic. While it’s not so many companies that are going into debt, more and more startups have started using their credit facilities as they are eager to conserve cash and shore up their balance sheets.
“As equity becomes more expensive, debt interest increases,” Allred said.
With interest rates rising and markets sometimes looking choppy, it’s fair to wonder if, like equities, debt will also dry up.
“It’s true that credit markets tighten when equity markets tighten,” Allred said. “But in general, debt capital… remains more open.”
While the framework surrounding venture capital debt may differ – from no mandates or covenants to more structured facilities – it can be a viable option not only for startups looking to weather a storm, but also to extend their track and the money they raised.
“It’s always been a good tool against expensive equity,” he said. “It can extend the life of that expensive equity.”
Illustration: Li-Anne Dias.
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