Venture Debt: Emerging from the Credit Crisis with New Borrowing and Refinancing Opportunities

Note: Capital Advisors Group is a Boston‐based institutional investment advisor that has been helping venture‐backed companies invest their cash assets for more than 20 years. Debt Advisors Group, the venture debt consulting arm of Capital Advisors Group, helps venture‐backed companies determine their optimum capital structure, identify appropriate lenders, source term sheets and negotiate deals.

What Is Venture Debt?

Definition: Venture debt or venture lending is a type of debt financing provided to venture‐backed companies by specialized banks or non‐bank lenders to fund working capital or capital expenses, such as purchasing equipment. Unlike traditional bank lending, venture debt is available to startups and growth companies that do not have a track record of positive cash flows or significant assets to use as collateral.

Credit Crisis of 2008 ‐ 09

Venture debt, like other forms of borrowing, was negatively impacted during the depths of the financial crisis that was triggered in 2008 by a liquidity shortfall in the US banking system. The lenders in this niche market tend to operate under varying financial structures, which determined how they fared during the crisis. For example, lenders that previously leveraged the capital they raised were unable to find reasonably priced lines of credit and, therefore, had significantly less funds to offer. Additionally, the lenders that were backed by hedge funds, which were facing their own difficulties, had little or no funds to lend and many stopped looking at new deals altogether. Finally, many lenders that were divisions of larger, more diversified lenders found it difficult to compete due to the perceived inherent high credit risk of lending to unproven, early‐stage companies and stopped lending or abandoned the market. As a result, most of the lenders in the space had extremely limited capital to lend and the remaining healthy few became much more cautious in their approach to deals and only pursued the very best lending opportunities. This general shortage of funds and lack of competitive pressure allowed the lenders to raise their interest rates and warrant coverage to much higher levels than at any time in the previous seven years.
As much as the credit crisis and other economic factors impacted the venture debt market, historically, it seems that the ability to raise venture capital has an even more direct impact on venture debt cyclicality, as well as its availability and cost. Our experience indicates that venture debt in a stable economic market usually averages between 7%‐10% of the overall venture capital invested. Venture debt, which was created in the 1970s, took hold in the 1980s and grew in the 1990s to its pinnacle in 2000, prior to the Internet Bubble. All of this venture debt activity and growth followed a track similar to that of venture capital investing. The first downturn in the venture capital and venture debt markets occurred when the Internet Bubble burst in 2001.
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