Startups borrowed money to avoid having to give up equity. After the collapse of market leader SVB, they should expect higher rates and fewer deals in the near future.
I2017, When David Rabie first launched Tovala, which combines a smart oven with a food delivery service, the idea sounded a little crazy. Then the epidemic came and the idea sprang up. He raised nearly $100 million for the Chicago-based business and also took several million dollars in venture debt from Silicon Valley Bank as an alternative to selling parts of the company. This allowed him to expand Tovala, which now has 350 employees and three food facilities in Illinois and Utah.
“SVB lent us money when the business was extremely unprofitable and at an early stage,” Rabie said. Forbes. “A lot could have been different if SVB hadn’t loaned us out in Series A. [venture-funding round]. There were no other banks willing to do that.”
Rabie is just one of many entrepreneurs taking risk debt from Silicon Valley Bank – the failing bank, which is its biggest issuer – as debt financing for venture-backed startups increases. Venture debt utilization reached $32 billion in 2022, more than fourfold from $7.5 billion in 2012, according to the Pitchbook-NVCA Monitor. SVB’s share in this issue last year was $6.7 billion. Rates ranged from 7% to 12%, and there were also guarantees that allowed the lender to earn a small equity stake in the business.
Since Silicon Valley Bank’s collapse last weekend, founders and investors have raised many questions about what could happen to their current debt. As panic spread during the bank run, the founders who took venture debt from the SVB worried that if they pulled their money out of the bank, they might have breached loan agreements that required them to keep cash there. Now some are wondering who might be buying the debt – private equity firms including Apollo Global Management reportedly interested – and eventually ending up with a minority stake in their business. “It’s a little irritating when you send investor updates to a mystery player,” says Matt Michaelson, founder and CEO of Smalls, a top cat food startup that has undertaken venture debt with the SVB.
More generally, there is the question of what happened to this fast-growing but largely under-the-radar market during a time of rising interest rates and investor timidity. “Venture debt will become more expensive,” says Jeff Housenbold, former CEO of Shutterfly and venture capitalist at SoftBank, who now runs his own investment firm Honor Ventures. “Companies that are fragile will not be able to collect debt.”
On Tuesday, Tim Mayopoulos, the new CEO of Silicon Valley Bridge Bank, the name of the entity operating under the FDIC trusteeship, said in a note that the bank will “make new loans and fully implement existing loan facilities”.
This has calmed some immediate concerns, but does not answer any longer-term questions.
To understand how cheap that money once was, consider the case of Rajat Bhageria, founder and CEO of Chef Robotics. It bought a $2 million loan facility with the SVB in December 2021 at an interest rate only 50 percentage points higher than the then-highest interest rate of 3.25% – an extraordinarily low cost of capital for a robotics startup. “Obviously the prime has changed a bit,” he says. “At that point, it was extraordinarily low and we were like, ‘How do we get this?’ It was like.”
Venture debt has been very helpful for a robotics company with high capital costs, and Bhageria still sees this as a positive, even though the interest rate has soared to 7.75%, raising borrowing costs. “There are a lot of complaints about venture debt,” he says. “They’re marketing it as a ‘runway extension'” – the time the business can continue operating without raising new funds – “but that’s not entirely true because very quickly you’ll have large debt service payments every month.”
Cat food CEO Michaelson has raised approximately $30 million in equity and has a $4 million debt facility with SVB. He says he is rethinking his company’s financing after the failure of the SVB. “We were under a lot of pressure from our investors to withdraw our money,” he says, when the bank assault began. But he was worried that the loans would default. When he finally tried to withdraw cash, the transfers failed due to a surge in demand. Although this is now a thing of the past, the experience made him rethink.
“I’m worried,” he says. “’Are we going to finance the debt elsewhere?’ The question is, what does the debt market do and will there be debt like this? The wind is blowing towards less debt, and people who are less likely to take on that debt will likely feel the pressure.”
Michaelson says he recently heard that a founder with a startup at a similar stage got a prepayment plan for venture debt at an interest rate of 13.5%. “This is much higher than we looked at,” he says. “At a given interest rate, it ceases to be as attractive as it used to be. You’re not just comparing debt to debt, but debt to equity. Depending on how valuations move in venture markets, it becomes less competitive.”
Since the collapse of the SVB, non-bank lenders have sought greater market share in the venture debt market. “While there were a number of startups at SVB, it wasn’t too busy to find an alternative in one place,” says Arjun Kapur, managing partner of Forecast Labs, a startup studio that is part of Comcast NBCUniversal.
As always when it comes to financing, the big question for the future is risk and cost. “It’s expensive right now because people are risk-averse,” says Housenbold. “Then there will be less venture debt in the beginning, which means founders will get more dilution. Venture capitalists will make more money and founders will own less of the company.”