The loss of SVB will undoubtedly constrain the availability of venture debt in the near term. But, SVB was not the only provider of such debt. Hercules Capital and Square 1 Bank, among others, provide the same or similar sources of capital to the startup ecosystem. It is also important to note that the collapse of SVB was unrelated to its traditional business model and, more specifically, the business of providing capital in the form of venture debt.
As a result, it is still important for us to cover this topic. First, to provide the overview we originally planned, but now, to also give our thoughts on its future.
So, what exactly is venture debt, who is it for, what are its risks—and now, what is its future?
What is Venture Debt?
Venture debt is a type of debt financing tailored to startups’ needs. It is typically provided by specialized lenders who understand the risks and opportunities of the startup ecosystem. These lenders usually focus on a borrower’s ability to raise capital to fund growth and repay debt rather than other measurements for obtaining debt, which focus on historic cash flow or working capital assets. In addition, unlike traditional bank loans, venture debt is often structured as a loan with warrants or equity kickers, giving the lender the right to purchase equity in the startup later. This structure allows the lender to participate in the startup’s upside potential while limiting its downside risk, which in turn assists in its provision of “traditional debt” capital to “non-traditional” borrowers.
Who is it for?
Venture debt can be a good choice for startups that need additional capital to scale their business but do not want to dilute their equity. It is often used to extend the runway between equity rounds, to smooth out cashflows, or to fund specific initiatives, such as product development or marketing. It can also be used as a bridge loan to help a startup reach profitability or to finance an acquisition. Venture debt is most appropriate for startups with a clear path to profitability and positive cash flow. Lenders will typically look for startups with a strong revenue stream, a clear plan for growth and a strong management team. In addition, the typical venture debt lender focuses on the capacity of existing investors to close one or more follow-on rounds in case the company fails to attract new investors. As a result, startups that are pre-revenue or have uncertain revenue streams may have difficulty obtaining venture debt financing.
What are its risks?
While venture debt can be a useful financing tool, startups must understand the risks. One of the most significant risks is the potential for default. Startups that take on too much debt may be unable to make payments, which can lead to bankruptcy or a forced sale of the company. Another risk is the dilution of equity. While less impactful than an equity round, venture debt lenders typically require warrants or equity kickers as part of the financing package, which can dilute the ownership stake of the founders and other equity holders.
Startups should also be aware of the terms and conditions of venture debt financing. Lenders may impose restrictions on the use of the funds, such as limiting the amount that can be used for executive salaries or marketing expenses. They may also require covenants, such as maintaining a certain level of cash reserves or achieving certain revenue targets. Startups should carefully review the financing terms and negotiate where possible to ensure they can meet the lender’s requirements.
What is the future of Venture Debt?
So, in light of the collapse of SVB, is Venture Debt still an available and viable alternative? As noted above, it is still available through various other providers, and even SVB has announced plans to continue providing lending while under FDIC stewardship. But is it viable? Our answer is yes. We are still in an uncertain equity funding market and valuations remain down – Venture Debt can provide a solution to those problems. Of course, it will be harder to obtain in the near term, and now, more than ever, startups must carefully select their lending partners. But that does not diminish its importance as a startup funding tool and valuable capital source in the ecosystem.
AuthorJason Acevedois a partner in thepractice group in theCorporate and SecuritiesDepartment at Klehr Harrison.
Learn more about ourKickoff with Klehrclient offering for new startups.
FAQs
Most commercial banks do not offer venture debt. A few banks, including Silicon Valley Bank, specialize in working with innovation companies and their investors and consider venture debt to be a core product offering.
What is the difference between venture debt and equity? ›
Venture debt is a type of debt that is typically used when a business is starting up or when it needs to grow its operations quickly. It's different from equity, which is what most people think of when they hear the word "equity." Equity refers to the ownership stake that a company's shareholders have in it.
How is venture debt repaid? ›
Venture debt is paid back in monthly instalments, whereas venture capital equity is only paid back by selling your company's shares. You prefer to have experienced advisors to help you grow. Equity investors will sometimes get a seat on your company's board and can become great advisors to startups.
What is the outlook for venture debt? ›
Traditional Venture Debt leads the market with a projected volume of US$26.2bn in 2024. When compared globally, the United States is expected to generate the most Capital Raised ( US$31.9bn in 2024).
Are SVB loans forgiven? ›
Yes. SVB and the SBA are accepting forgiveness applications for PPP loans funded in 2021. Apply for Forgiveness of your PPP 2021 Loan ahead of your deferral period end date.
What happens if you owe money to SVB? ›
You owe money to the SVB
If you have received too much money from us, you will have to repay it. If you think you cannot repay it, please get in touch with us. We will help find a solution, for example by arranging a plan for repayment with you. We can also give you more time to make the repayments.
How risky is venture debt? ›
While venture debt can be a useful financing tool, startups must understand the risks. One of the most significant risks is the potential for default. Startups that take on too much debt may be unable to make payments, which can lead to bankruptcy or a forced sale of the company. Another risk is the dilution of equity.
Is venture capital considered a debt? ›
The key difference between venture capital and venture debt is that venture capital is an equity investment made by a VC firm into a startup, whereas venture debt is a loan taken up by the startup to be repaid with interest during the loan tenure.
What is venture debt for dummies? ›
Venture debt is a form of non-dilutive funding for early stage companies. Many venture debt deals include warrants which may be exercised to purchase common stock in the borrowing entity. As a debt instrument, venture debt has a higher liquidation priority than equity.
What happens if you can't pay back venture debt? ›
A venture loan creates a cash expense for the company every quarter. Unlike equity, it needs to be repaid or refinanced at some point in the future. If the loan is not repaid, the venture lender can take over the company's assets.
Annual interest rates are typically 12%. Monthly repayments typically include both interest and capital, and are paid each month for the life of the loan - usually around 36 months. Venture lenders will typically charge a facility fee of 2% of the loan amount, payable in cash when the loan is funded.
When should I take on venture debt? ›
When to take on venture debt. Venture debt is typically made available alongside an equity raise or within a few months of a round closing. It can be made available between rounds, but companies should have around 9-12 months of cash runway.
What is the largest venture debt fund? ›
Silicon Valley Bank was by far the largest provider of venture loans to the startup ecosystem, with more than $6.5 billion in loans to early- and mid-stage companies in 2022 out of $26.5 billion in total venture debt funding industrywide.
What is the failure rate of venture debt? ›
The default rates in venture debt lending typically range anywhere from 1% in a really good fund to 5% to 8% in a tough startup environment.
Is venture debt private debt? ›
Venture debt is a key part of the private credit universe. It's a form of direct lending to growth-stage technology companies that differs from traditional lending in a number of important ways.
Is SVB a venture capital firm? ›
For nearly four decades, SVB has been the go-to bank for Venture Capital investors.
Who offers venture debt? ›
Venture debt is a type of loan offered by banks and non-bank lenders that is designed specifically for early-stage, high-growth companies with venture capital backing. The vast majority ofMost venture-backed companies raise venture debt at some point in their lives from specialized banks such as Silicon Valley Bank.
What type of investments did SVB make? ›
The funds were invested largely in U.S. Treasuries, U.S. Agencies, and U.S. Agency mortgage securities.
Does SVB do investment banking? ›
SVB serves the world's most innovative companies and their investors via commercial banking with Silicon Valley Bank, investment banking with SVB Leerink, private banking and wealth management with SVB Private Bank, and funds management and investment with SVB Capital.
