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What exactly is venture debt?

This specialist form of lending is finally seeing its moment in the sun 

startup woman


This is an article from the October edition of AltFi's new magazine The Financial Innovator, which is available for free here.

Venture capital rode higher and higher for almost 15 years before hitting a macroeconomic dose of reality that popped the bubble last year. This was due to a combination of factors that prompted a swiftly rising interest rate environment  

The vast majority of attention over this past decade and a half was on the more glamorous equity side of the venture landscape, where investors swapped, to put rather simply, a large cheque for a slice of an up-and-coming startup in the hope it would multiply many tens or hundreds of times over. A bet with a 100-1 odds of success. 

Venture debt, equity’s shyer cousin, was typically kept away from the limelight. That was at least true until startup valuations took a turn for the worse just when many high-profile firms needed a cash injection. Now venture debt is on the rise. 

Unlike its equity stable mate, venture debt does not offer the chance of making multiples back on an investment. Rather, it is a specialist type of lending, albeit one that has both interest rate and principal to repay over a given time period much like any loan.  

A key difference is it can be highly risky as not all startups make it to the profitability promised land. 

There are a number of crucial benefits to accepting venture debt over typical equity capital, although the two often go hand in hand. The most important benefit is that it’s ‘non-dilutive’ i.e. you can take on more funding, especially at lower valuations without existing investors and staff losing out on some of their existing stakes.  

Ironically, one of the tech industry’s biggest providers of venture debt — Silicon Valley Bank — collapsed at the exact moment demand started to rise in the first quarter of 2023. 

Stephanie Heller, partner at Bootstrap Europe, a provider of venture debt funding that recently purchased SVB's distressed assets in Germany, says a recent series of events in the tech world have shed light on a type of funding not visible before.  

These are the collapse of SVB and the acquisition of SVB portfolios respectively by Bootstrap Europe in Germany, HSBC in the UK, and First Citizen in the US. The acquisition of Kreos by Blackrock is another example. 

“We actually do not think venture debt is booming at the moment. It’s currently benefiting from a catch-up effect from SVB volumes being reshuffled, combined with the spotlight on the asset class,” she said. 

Other big banks are starting to get very interested in venture debt with SVB’s collapse prompting a vacuum in funding. Volumes are only just catching up this quarter, Heller says. 

“Looking at the high-performing portfolios of SVB, banks have realized that technology lending is a fantastic business line. Stifel, JPMorgan, Mitsubishi UFJ have also started hiring ex-SVBers to position themselves into the space,” she said. 

Venture debt is not suitable for all companies, but in the aftermath of the recent economic wobble and the ensuing rising interest rates, venture debt, once overshadowed by the glamour of equity investments, has come into the spotlight.  

With the recent collapse of SVB and the subsequent acquisition of SVB portfolios by various institutions, the landscape of venture debt is evolving, attracting interest from prominent banks seeking to fill the funding void left by SVB's demise.

As demand continues to rise, venture debt appears poised for a significant resurgence in the market. 

This is an article from the October edition of AltFi's new magazine The Financial Innovator, which is available for free here.

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