The magic of live panels is that speakers always make comments you didn’t expect — even if you are the moderator and no matter how much prep you have done. I know this from experience: It happened to me at TechCrunch Disrupt 2023.
The panel in question focused on capital-intensive startups, so I knew that we were going to discuss alternatives to venture capital as sources of funding. What I wasn’t prepared for was for the three panelists to agree on dissing venture debt. I was clearly surprised.
“Many startups rely on venture debt: It’s both a cheaper alternative to raising equity and can serve as a capital tool that helps companies build in ways that equity isn’t great for. For some companies in capital-intensive areas like climate, fintech and defense, access to debt is often the only avenue to growth or scale,” my colleague Rebecca Szkutak noted a few months ago in her survey of investors on the topic.
As a manufacturing tech company geared toward space and defense, Hadrian footed the bill for the kind of capital-intensive companies that are supposed to crave venture debt. And yet on the Builders Stage, CEO Chris Power warned fellow founders against it. “Unless you’re in real trouble, I would avoid venture debt at almost all costs,” the Australian entrepreneur cautioned.
To understand the issue with venture debt, it is important to note that the devil is often in the details — or in this case, in the contract terms. One of our investor survey participants, NextView partner Melody Koh, gave a telling example:
“If the [venture] debt provider is a bank, the covenants usually involve a clause that the company keeps all its cash deposits with that particular bank so that it can serve as the collateral against the drawn credit line.
This is a perfectly reasonable requirement from the lender’s point of view, but it might not be the best treasury/cash management strategy for the company. This needs to be taken into account as the “cost” of utilizing such a source of capital.
That exact scenario happened to Nikki Pechet, who was also participating in the panel at Disrupt. The co-founder and CEO of homebuilder Homebound, she recalled how a $5 million venture debt line her company obtained from Silicon Valley Bank turned out to not be so attractive, despite its “reasonable” interest rate. The terms said that the startup needed to keep at least that amount in an SVB bank account that the bank could sweep once it hit $5 million. Not exactly worth paying for, in her view.
Since SVB was also a major provider of venture debt to startups, its collapse likely didn’t win this type of financing any more favors, but criticism of this financing modality is both broader and older. Fellow panelist Sophie Bakalar, a partner at Collaborative Fund and former entrepreneur, called venture debt one of the two things that blow companies up “when they least expect it,” alongside founder issues.
There’s a caveat, Bakalar conceded. “When you have very stable predictable revenues, that’s really the time when you can bank on venture debt and when interest rates are not astronomically high.” But even then, Pechet is not a fan. “If you are in a place where you have stable and predictable revenues, that’s fantastic, and that’s financeable; but don’t get venture debt — go to a real bank!”
Beyond venture debt?
Pechet’s advice isn’t only about venture debt: “Try to not take the venture version of a real financial instrument,” she recommended. She also named some alternatives to venture debt, such as the corporate revolvers that banks offer to companies that have steady revenues, or the option to finance assets; not everything needs to be uncollateralized. “There’s a bunch of different ways to do it, but go find experts who can look at your business and help you think about it,” she urged.
Of course, it is still way too early to write off venture debt entirely, even with rising interest rates. The debate is still open on whether it’s worth it and could even lean toward a yes for later-stage companies. But with earlier-stage companies ready to shake every tree for dollars, it is hard for them to say no to (venture) debt, even if it doesn’t always play out nicely in a down scenario. Just be warned: Yes, beggars can’t be choosers, but you may also be choosing your killer.