Why startups are raising more venture debt as VC dollars near all-time records

Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.

As I write to you, SaaS and cloud stocks are busy setting fresh all-time highs and as we’ve seen, venture interest in modern software companies is pushing more money into the sector. But despite it appearing to be an incredibly good time to raise equity funding, venture debt and revenue-based financing appear to be having a moment.

So why are more folks talking about and raising debt to help power their startups, even when valuations are high and there is a lot of venture capital to be raised?

As with all explorations of complex, evolving trends, there’s no one answer. But, some data from a 2019-era survey on venture debt and a conversation I had with equity-free SaaS finance shop Element Finance’s John Gallagher (Element is a Scaleworks spinout) help explain what’s going on. Let’s start with how big the venture debt world is and how fast it is growing and then turn to what’s powering its expansion.

Rising debt

The data we’re going to discuss is directional and probably pretty accurate, which is just fine for what we want to do today: detail a general trend of rising venture debt volume over the past few years to confirm what we’ve presumed to be a trend for some time.

Thanks to a report from last year undertaken by Kruze (a startup accounting and HR consultancy), what the firm described as the “largest survey of the venture debt market” undertaken, including firms that “control well over half of the venture debt dollars in the United States,” here are estimated totals of domestic venture debt volumes for the past half-decade:

  • 2015: $6.2 billion
  • 2016: $5.8 billion
  • 2017: $6.5 billion
  • 2018: $8.4 billion
  • 2019: $10.1 billion

Aside from 2016 presenting a modest dip, venture debt has grown sequentially in recent years.

But while $10.1 billion sounds like a lot of money, it isn’t on a comparative scale. Recall that Crunchbase News projected nearly $300 billion in total global venture activity last year. As we’re discussing U.S. totals, however, for venture debt, we need to narrow sum. Domestically, Crunchbase News put U.S. venture capital activity at at $132 billion in 2019, while an industry group released a $136 billion figure.

Either way, venture debt is still tiny in contrast. In many ways this is reasonable, as venture debt in all its stripes is not a good fit for all types of startups, and it also isn’t a full replacement for venture capital. That said, it appears to be tracking higher as more firms rise in the space — like Element, yes, but also Earnest and RevUp Capital — and the products that they offer diversify and mature.

We can rest content that the venture debt is growing, even if it’s still small as a fraction of the venture market. Why it is growing, however, is what we really want to know, so let’s get into that now.


Returning to the Kruze survey, the key reason startups are raising venture debt is by far and away a runway extension to “make the company more valuable [in its] next round.”

You can read that in two ways:

  1. Startups want to target a higher, next-round valuation to limit dilution in their next round. They can accomplish this by using debt to allow for another quarter or two of growth, boosting their revenue base and thus achieving a higher valuation when they go on to raise equity financing.
  2. To avoid a downround. Perhaps a few quarters of growth will save a startup from having to raise at a lower valuation than they set during a preceding funding event; down-rounds are pretty awful for all parties but new investors, as existing shareholders tend to get diluted out of their stakes.

But there’s another reason why venture debt might be picking up steam. To get a handle on that, let’s bring Element Finance’s Gallagher into the mix. In a recent conversation with TechCrunch, the following exchange discussing for whom revenue-based financing might fit stood out:

TechCrunch: Is there a whole category of SaaS companies that are just looking to grow 40% to 50% instead of 100%, and are willing to burn a lot less money for whom [revenue based] financing is the best possible option? I’m trying to imagine companies that are not growing slowly, but also aren’t growing at hyper growth. That is, and I’m curious if this kind of financing is kind of the perfect match for their approach?

Gallagher: You know, a lot of founders that I talk to are building sustainable businesses that you know, one day they’re going to be making profits and money [from]. They’re been building sustainable businesses, they want to be around for a long time. And maybe they understand that not every business is going to be a Facebook or a unicorn. You know, if they take VC money and try to be a unicorn, it might not work out well for them.

TechCrunch then asked Gallagher how many modern software companies fit into the cohort that we were discussing. Put more succinctly, how big is the middle class of SaaS? Taking a quick off-the-cuff estimate, Gallagher said around 80 percent of SaaS companies would be a good fit for revenue-based financing.

The middle class of SaaS is quite large, then.

Our two answers might seem pretty far apart, but I don’t think that they are. Startups looking to use venture debt to delay equity fundraising (venture capital) and startups looking to use venture debt to replace some equity fundraising are pretty close, I reckon. The takeaway from the pair of answers — one largely dealing with SaaS companies that raise venture capital as a majority of their funding and one dealing with a group that might raise a majority of debt — is that venture debt probably has long-term product-market fit across the modern software spectrum.

That’s important. SaaS is a key category of the startup market when it comes to returns, especially in recent years (check the IPO rolls). If VCs have to compete more frequently for space in deals with debt in the future, it could limit their ability to put capital to work in SaaS companies. That, in turn, could limit aggregate venture returns.

More when we have more data, but this is a fun space to watch evolve.