A term sheet from Sequoia or Khosla Ventures opens a lot of doors for a founder. But increasingly, it’s no guarantee of venture debt funding.
One year on from the Silicon Valley Bank crisis and the widespread disruption to the venture lending market, more lenders have moved upmarket.
This has had knock-on effects on startups. Securing a debt facility is significantly more challenging for seed and early-stage founders, especially those building in industries like fintech and consumer tech that have seen valuations drop dramatically.
“The dynamic has completely flipped,” said Zack Ellison, co-founder of private credit firm Applied Real Intelligence, which offers venture debt to startups. “It used to be that lenders would ask founders, ‘Who’s backing you?’ If they’d raised millions from VCs like Sequoia, Andreessen and Founders Fund, that was often good enough. It no longer is. The bar is now much higher.”
Seed and early-stage companies have seen the largest drop in venture debt deal volume. That’s in contrast with equity VC deals: earlier stages held up better than later stages last year.
PitchBook recorded 665 early-stage venture debt deals in 2022. By the end of 2023, the equivalent figure had dropped to 408 deals, a 39% decline. Pre-seed and seed-stage VC debt was similarly depressed.
As it became clear how many startups took on overly inflated valuations in 2020 and 2021, lenders stopped following VCs’ leads, according to Ellison. And they now have more leverage to set terms.
VCs can take swings at dozens of companies, and if a few pay out, they can drive an entire fund’s returns. Venture debt lenders have to be more calculated. Their upside is capped and their returns are beholden to the ability of startups to pay down debt. There also tends to be more hand-holding involved when lending to young companies. And at a time when startups are struggling to get funded, lenders’ risks are higher.
SVB’s fallen crown
Prior to its crisis in March 2023, SVB was the lender of choice for seed and early-stage startups. SVB’s market share of the bank venture debt market has gone from 50% to approximately 20% of the market, according to John Markell, managing partner at debt advisory firm Armentum Partners.
Markell, who surveyed over 20 banks that offer a venture lending product, found that the bank is no longer even the biggest originator. SVB’s head of corporate affairs, Carrie Merritt, disputes this, saying that by its own estimate, “SVB today continues to do more venture debt lending than any other single institution.”
SVB’s trademark approach involved building special relationships with startups, which often meant offering favorable terms on their venture debt loans on the condition that the startup did all of its banking with SVB. That model broke in the wake of the bank’s collapse.
In Ellison’s words: “No CFO with any experience would put all their deposits in one bank now.”
Dozens of senior SVB bankers jumped ship in the wake of the crisis to the likes of HSBC, Stifel and JP Morgan, bringing with them their reputation and personal relationships with potential issuers. However, the growing pool of bank lenders hasn’t been enough to fill the hole left in the seed and early-stage venture debt market, partly because of the higher bar placed on companies.
Before SVB’s collapse, lenders’ due diligence on high-growth startups was largely a cursory step in the final stages of a deal. Now, lenders are doing much more front-end due diligence on potential borrowers. Bank lenders are heavily discounting insider round valuations and relying much less on investors’ reputations.
“Lenders are calling VCs themselves directly to check [the syndicate],” said Troy Zander, partner at Barnes & Thornburg.
Featured image by Noah Berger/Getty Images
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