Venture debt sweet spot may be short-lived
Venture debt lenders are currently in a sweet spot, with higher rates potentially increasing returns and lower valuations in the equity market pushing founders to seek capital in the credit markets, but it may be short-lived.
Venture debt is a type of loan that is designed specifically for early-stage, high-growth companies with venture capital backing.
Demand for venture debt has increased over the last year as founders have looked for alternative financing instead of raising a down round. With many banks pulling out of lending to venture-backed companies, as well as the failure of Silicon Valley Bank – one of the largest lenders in the space – a gap has been created in the market that debt funds could take advantage of.
According to Mark Solovy, managing director and co-head of technology finance at Monroe Capital, when Silicon Valley Bank had its problems and was eventually bought, there was a massive disruption in the marketplace as it was the largest provider of venture debt. Although the need is still there, banks have pulled back, creating an opportunity for groups like Monroe Capital to take over some of the market share.
Read more: Investment giants fuel drastic increase in direct lending
Since 2020, 54 venture debt funds have raised $6.2bn (£5bn) globally, according to PitchBook data, and they are ready to deploy their capital.
But if the markets improve and valuations rise, that opportunity will recede, according to Lorna Robertson, head of funds at Connection Capital.
“As soon as the equity market comes back, this is going to be less attractive and it’s quite restrictive if you’re tied into a loan for five to seven years,” she said.
And although for some it may be attractive, there are pressure points investors should be mindful of, she said, which is what has kept her from investing in venture debt funds so far.
Read more: Direct lending trusts slowly disappear as discounts persist
For Solovy though the idea that venture debt means taking on a relatively higher level of risk is more perceived than actual.
“Because these companies are traditionally losing money it means they need to continue to raise money,” he said. “We believe that the companies we back can raise venture capital but they don’t want to raise at a lower valuation. The valuation they raise venture capital at does not impact our ability to have our loan to them repaid.”
Read more: Apollo estimates private credit market is worth $40trn