The collapse of Silicon Valley Bank (SVB) was not the end of venture debt, but it was likely the end of companies raising venture debt with the same ease that many were accustomed to.
TechCrunch+ recently spoke to five different VCs about the state of venture debt in the wake of SVB and then First Republic Bank’s collapse, and all of them said they don’t think the recent bank failures signaled the end of venture debt. Rather, they expect the process of raising this kind of debt will start to look a lot different.
How will it change? While several investors felt venture debt will remain a cheaper option for founders than equity, all of them agreed that it would get more expensive in the future.
Just how much more expensive, however, is hard to pin down. Sophie Bakalar, a partner at Collab Fund, thinks macroeconomic trends will drive prices up. “Capital markets are certainly changing, so founders should expect this form of capital to rise in price as economic trends increase and the supply and demand dynamics in the market change drastically. We’re telling founders that they should be prepared for the possibility of higher cost of capital now and in the foreseeable future.”
Ali Hamed, a general partner at Crossbeam, has already seen prices climbing, and as that trend continues, he expects lenders will increasingly look for strong underlying unit economics. “Our prediction is that venture debt lenders will begin to rely less heavily on what the “loan-to-value” of a business is, and instead start to focus on capital efficiency, ability to become profitable, etc.,” he said.
Bakalar echoed that prediction, saying, “Startups are expected to have a certain amount of cash on hand, typically enough to cover several months of operating expenses, in order to demonstrate their ability to weather any financial storms that may arise. Today, this several-month emphasis is more like one-year-plus.”
Stricter requirements like these may make non-dilutive capital like venture debt harder to reach for younger companies, startups in more capital-heavy sectors, or companies that won’t reach an exit or generate revenue for a long time.
“I think venture debt lenders will certainly get more conservative in how they think about companies that rely heavily on capital markets to be successful, or companies who will wait to see financial traction catch up to a narrative for more than a couple of years,” Hamed said.
Melody Koh, a partner at Nextview, thinks lenders will pay more attention to what a startup’s “equity cushion” looks like, which she defined as how deep the pockets of a company’s existing and future VC backers are.
In addition to this new focus on fundamentals, multiple VCs expect relationships to matter less in this environment than they used to. Peter Hébert, a co-founder and general partner at Lux Capital, feels the industry will start moving away from the “soft banking relationships” prevalent in venture debt so far.
“Historically, the model was, in essence, “underwriting the underwriters” — relying upon decades of trusted personal relationships and on-the-ground knowledge to ensure that VCs would stand behind their portfolio companies and mitigate otherwise early-stage business credit risk,” he said. “Increasingly, venture lending will resemble other forms of credit underwriting.”
Simon Wu, a partner at Cathay Innovation, agreed, and advised startups to think more critically about what kind of venture debt they are raising and where it is coming from. “Startups should always look at duration, price, covenants and the timing of repayments,” he said. “That hasn’t changed. However, given the uncertainty in the macro environment, covenant levels set by banks might be too onerous to build a business around.”
Wu added that he’s heard some banks are looking to only lend to startups that keep all of their money at that bank — a Silicon Valley Bank special.
Bakalar pointed out that her team is talking to companies to ensure founders understand the potential downsides that could arise from raising venture debt. “If revenue doesn’t grow as quickly [as required] or margins are lower, we want founders to understand the potential downside scenarios and make sure they have an adequate buffer,” she said.
All that said, it appears venture debt will remain a great option for the companies that can get it. And like all markets, despite a slowdown or disruption, VCs think that good companies will still find the resources that they need.
“Given the rising cost of equity that continues to play out in the private market, it’s likely that debt will still be cheaper to use to scale businesses — assuming there is a repeatable motion,” Wu said. “However, it will be on a case-by-case basis given how expensive it will be going forward.”