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Venture Debt


EXCLUSIVE: VENTURE LENDERS TURN MORE CONSERVATIVE ON DEAL TERMS AS STARTUP
VALUATIONS COOL OFF

By Madeline Shi
March 23, 2022
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The era of venture debt lenders offering startups relaxed loan terms may be
winding down.

After years in which venture debt specialists, locked in fierce competition for
deals, sweetened loan terms to appeal to fast-growing companies, stock market
volatility since the start of 2022 is making some lenders more conservative when
underwriting deals.

Lenders are reining in loan sizes, shortening interest-only repayment periods,
and taking other steps to react to changing market dynamics.

The shift follows recent public market declines in tech stocks and newly public
companies, which have created a gap between private and public valuations. That
disconnect has pushed some private lenders and investors to reevaluate how
eagerly they pursue deals and the valuations they're willing to accept when they
do decide to invest.

"Valuations have started to come under some pressure for companies in the A's
and B's rounds," said Max Wolff, a managing partner at Leste Clearway Capital,
the venture debt arm of PE firm Leste Group. "Risk is perceived much greater
than it was three months ago."

At the same time, current market conditions are favorable for the venture debt
market to have another robust year. Demand is increasing among borrowers facing
difficulties in raising the money they need from equity investors, and debt
financing helps founders minimize dilution.

The US venture debt market has grown rapidly in the past decade, with total deal
value rising from $4.4 billion in 2010 to about $33 billion last year, according
to PitchBook data.

The increased amount of capital going toward venture debt deals has led to a
run-up in loan sizes, according to investors and lawyers.

"The phenomenon of deal structures getting more favorable to borrowers happened
pre-COVID and accelerated during the pandemic, because, to everyone's surprise,
deal activity just went through the roof, no matter if it's venture capital or
venture debt transactions,” said Troy Zander, a venture debt attorney at Barnes
& Thornburg.

Last year, lenders signed 182 venture debt transactions larger than $100
million, representing 5.7% of total disclosed deals. That's an increase from the
96 such deals done in 2020, accounting for 3.4% of the total, according to
PitchBook data.
 
 


In addition to a run-up in transaction sizes, venture debt was also offered at
lower interest rates and with less stringent covenants in the past five to 10
years, reflecting strong investor demand, industry attorneys said.

One example of loosening standards is certain loans that don't require the
borrower to pay back the principal for four or five years, extending the typical
18-to-24 month interest-only period, according to Zander.

Competitive pressures have also led lenders to request a smaller number of
shares through warrants and remove covenants that require a borrower to keep a
minimum amount of cash on hand or maintain debt ratios at certain levels, Zander
said.

However, that trend appears to be reversing as some lenders take a more
conservative stance on deals.

More lenders now prefer to offer loans in tranches, allowing the borrower access
to the capital in multiple allocations only after meeting certain performance
metrics. Some are tightening up covenants by shortening the interest-only period
or requiring borrowers to keep more capital on balance sheets to extend their
cash runway.

"A lot of venture debt is made on the assumption that the guaranteed repayment
for the debt is your next equity round," Wolff said. "But if lenders start to be
a little nervous about that, they will see these opportunities differently."

The market for late-stage private companies has already seen a decline in deal
sizes, according to some venture lenders, and others expect that valuation
pressure will trickle down to early-stage startups in the coming months.

"Private valuations will come down because the public market won't be there,"
said Chad Norman, a senior portfolio manager at Avenue Capital Group.

"When valuations get hit, loan sizes become smaller accordingly," he said.

Featured image by Ekspansio/Getty Images
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TAGS:

 * Venture Capital,
 * Lending,
 * Venture Debt


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