‘Venture debt’, which has been on the rise in recent years, is risky… VC heavyweight warns startup founders

Startups often raise money through venture debt (loans) in addition to traditional equity rounds (investments). A healthy company can take out a small amount of borrowing to increase flexibility without having to sell itself. But companies that are already in trouble may borrow to postpone painful decisions.

In 2019, cash-strapped clothing maker Outdoor Voices raised $15 million through venture debt, according to PitchBook data. equivalent), the valuation fell by 70% in a round less than a year later.

By 2022, startups had over $31 billion in venture debt, according to PitchBook data. This is a slight decrease from the previous year, but when considering other data, it is clear that we cannot be happy.

After all, in 2022, venture capital (VC) equity investments will drop by 30%. In other words, in Silicon Valley, the situation in the debt and equity markets is beginning to diverge significantly.

This could pose a problem for the venture debt business model, Sachs said.

“Venture debt is meaningless unless the founders are able to successfully raise their next round of funding and pay off the venture debt.”

In the past decade, when funding was readily available and valuations were skyrocketing, these issues didn’t arise. Even companies that struggled to repay their loans were able to repay them with another funding round at a higher valuation than the previous one.

However, it is now difficult to raise funds from VCs, and investors are seeking investment projects with lower valuations and more favorable conditions for investors. Paying off huge debts in these circumstances may not be as easy as it used to be.

“Founders think of venture debt like an equity round with no dilution or a certain amount of warrants,” Sachs said.

“However, what the founders don’t realize is that they will have to repay this loan with the money they raise in the next round, which will take place in 1-18 months. It makes it harder to raise money because new VCs want to invest in companies that don’t get their money back to banks.”

Judgment Day for Venture Debt

Samir Kaji, a former venture debt lender and host of the podcast “Venture Unlocked,” recently said:on TwitterOpinion on Judgment Day brought by Venture Debt.

Kaji expects a lot of tough conversations between founders, investors and lenders over the next few years as they can’t sort out debts they can’t repay.

“These tough conversations have already started,” Mark Suster of Upfront Ventures said in response to Kaji’s tweet.replying on twitter.

“Venture debt is already a hindrance to future fundraising. VCs are hesitant to put in another $5 million if they know that $3 million of it will be spent repaying the debt. Although we knew it from the beginning, we are now in a situation where we are reminded again that borrowing money is not free.”

Historically, venture debt has had a significantly lower risk of bad debt than other forms of private lending. But that may change in the near future.

Venture-debt giant Silicon Valley Bank said in its most recent quarterly earnings that it expects bad debts to rise 241% year-over-year to $420 million. That’s still less than 1% of Silicon Valley Bank’s total lending, but its rising numbers may mean the future is in jeopardy.

“All this venture debt is coming back in bulk right now,” Karakanis said on the “All In” podcast, adding that he’s already seen “some pretty dire term sheets.” I am adding. Lenders are buying cash-strapped companies for pennies to wipe out early investors.

Karakanis said he expects to see more of these disastrous cleanups in the future, “and we’re going to see human nature.”