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Venture debt is
widely discussed in startup circles, but often misunderstood. Venture debt is a
catch-all term referring to loans tailored to the needs and risks associated
with investor-backed tech and life science startups. Venture debt often is
secured at the same time or shortly after an equity round – with a goal of
extending runway and increasing valuation before going out for the next round.
Companies in the venture
ecosystem share a capitalization strategy deliberately organized around raising
equity from professional VC’s to
massively accelerate their growth rate and scale. The venture debt market
consists of a relatively small universe of lenders that provide loans which
explicitly rely on the borrower’s continued access to venture equity as the
primary source of repayment for the loan. This type of loan, typically referred
to as growth capital, differs from loans that rely on other sources of
repayment, such as cash flow or the collection of accounts receivable. These
loans are targeted at companies that have raised institutional equity from
venture capital firms or similar sources.
Venture debt lenders evaluate
both the durability of support from existing investors and probability of
attracting interest from new, outside investors to ensure the loan is repaid. For
these reasons, venture debt is deployed most broadly at the Series A stage,
when reserves among the existing syndicate are typically at their apex and
valuations are heavily influenced by anticipatory metrics, including technical
or product development milestones.
Looking back over the last eight
quarters of proprietary SVB data, debt-to-valuation ranges have remained fairly
consistent – buoyed by either increasingly larger equity round sizes at the
early stage or increasing valuations at the late stage.
Debt to Valuation by Quarter
When we look by Series, the picture becomes clearer.
Debt to Valuation by Series
Typically Series A-B companies
raise equity that supports 9-12 months of runway and venture debt supplements
that by providing an additional 3-6 months. While the median debt-to-valuation
ratio is typically higher for Series A-B than for later stage companies, the
average equity round is also smaller which in turn means the average loan size
is smaller. This provides early-stage venture debt lenders with portfolio
granularity when they are making a decision about a deal.
In contrast, later-stage
companies (Series C-D) typically have lower median debt-to-valuation ratios,
but the average loan size grows along with the equity size for each successive
round. The universe of companies that receive successive rounds of equity shrinks
over time as valuations are increasingly correlated to business execution and
less competitive companies disappear. Loan size has increased with each
successive round, too much debt can impact future equity negotiations.
In today’s environment, some patterns
common to the venture debt market are shifting. In prior business cycles, the
equity progression described above (larger equity rounds / lower
debt-to-valuation ratios) often forced the most successful later-stage
companies to diversify their investor syndicate beyond the VC ecosystem – in
order to satisfy the increasingly larger funding cycles required to grow at
scale. It was also generally true that super-sized equity rounds often could
not be accommodated in the private market, which drove companies to the public
markets or an M&A deal. But now this
pattern has reversed.
The abundance of cheaper,
late-stage capital has changed these dynamics. Super-sized rounds are now
routinely being filled with private rather than public equity. In addition to
being abundant, later stage private equity has also been relatively cheap (for
breakout companies) in historical terms. As a result, the super-sizing of the
largest late stage funding’s has effectively outstripped the capacity of the
venture debt market to ‘match fund’ in some examples, and the highly
competitive pricing dynamic for those same examples has increasingly placed
later stage equity in direct competition with venture debt.