venture debt
Maurice Werdegar

Yep, more later-stage companies are taking on venture debt

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Venture debt has been much in the news lately. Earlier this month, for example, we learned that ModCloth, an online company that sells vintage women’s apparel, is being acquired by Jet.com for less than investors poured into the company — largely because ModCloth was tripped up by unsecured bank debt. More recently, we learned that after failing to land an investor or buyer, the music streaming service SoundCloud decided to raise a $70 million debt round.

Are desperate times beginning to call for desperate measures? That might be an overstatement; at the same time, the venture debt firm Western Technology Investment (WTI) has seen plenty of cycles over its 37 years in the business, and CEO Maurice Werdegar says the firm just finished its busiest quarter ever.

We talked with him late last week in a chat that’s been edited for length.

TC: It seems like venture debt is popping up in more deals. True or not true?

MW: The long trend is definitely that venture debt continues to play a moderately increasing role. The role it’s intended to play is to complement a company’s equity strategy — to help extend [funding] from one round to the next, adding time and giving companies and their teams the optionality of having more data and reaching certain inflection points before heading into that next round.

TC: And you’ve traditionally focused on early-stage companies as a result. You provided debt to Jet.com as part of its massive Series A round, for example. But it seems like later-stage companies are using more debt, too.

MW: We’ve been very busy in late-stage rounds, too. I think people raise a little too little capital; they underestimate how long it will take to raise their next round, so debt has become an interesting supplement to that.

TC: Are you seeing an uptick in the number of older companies knocking on your door?

MW: We can’t get all the deals coming to us [there are so many]. Of course, there’s always the adverse selection question that goes hand-in-hand with that demand: Are you getting the call because things aren’t going well or are these companies that are trying to be more thoughtful and strategic and proactive about their fundraising?

TC: Can you name names or sectors?

MW: It’s just a giant pool of companies. If you think of the 30 most important companies over the last 15 years, we visited with more than 20 percent of them. It’s a core part of the way that companies think about optionality.

TC: What do you make of this SoundCloud deal?

MW: The lenders in that [deal] are counting on SoundCloud’s enterprise value being enough to cover its debt [as collateral]. That wouldn’t be a bet that I’d necessarily be as comfortable with. Things can go wrong and collateral can be worth less than you think. When things fail, they fail badly. Companies just go out of business. They can definitely go to zero in this industry. I’ve never met with SoundCloud and I’m not saying anything about the company specifically, but the idea of being the last-resort stop is dangerous.

TC: Your industry is known for taking money back when it gets nervous. Do you think founders fully understand how covenants work?

MW: We don’t take covenants, actually. Other approaches [from other debt lenders] are to take more risk but to be able to get their cash back if they are nervous. So they monitor companies’ performance and if they’re nervous, they can either force VCs to put in more money or get their money back. It’s a little like the insurance policy that doesn’t work when you’re in an accident.

[Silicon Valley Bank]’s debt is very inexpensive, for example, but it comes with covenants. We’re on the more expensive side, but it’s more like equity. We’re pretty open about the fact that we’ve lost money more than 100 times, and by the way, we always see the trouble coming.

TC: Is more trouble coming now, broadly speaking?

MW: Everyone needs to grow into their valuations, and that’s not easy to do if you raised in 2015, which was the high-water mark in a lot of rounds. So I’d say instead that a lot of insiders are looking at debt as complementary, to make each round last longer. You can only do so many inside rounds before insiders get tired.

TC: So it does sound like you’re seeing more older startups.

MW: We’re having the most active quarter in our 37 year history — period. Is there an uptick in older companies? Yes, but they feel like healthy companies that are nearing profitability [and they’re coming to us for a variety of reasons]. Their investors might be tired. They might not like the valuation they’d get if they were to head out right now. They might want to wait on a strategic [investor or acquirer] to get a better price. They might be wanting to make an acquisition and to use venture debt for that.

They might also be looking to refinance other venture debt. In some cases, lenders won’t renegotiate, so companies are looking for other ways to [stretch out their funding]. It’s not unlike refinancing your home to get a lower payment.

TC: How can founders be sure they’re striking the best deal when it comes to venture debt?

MW: Different lenders take different approaches, some with hidden covenants and clauses, but I’d say it’s their law firm’s job to advise them. They’ve seen every lender 50 times so should be able to advise on what these different deals mean.

TC: How big is this market right now?

MW: There are around 18 venture debt players; it’s a very robust market. We represent about 10 percent of the venture market, if you were to market size it. So if you read that startups raised $20 billion last year, then that probably includes about $2 billion of venture debt.

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