As Traditional Funding Sees Headwinds, Venture Debt Investments Set to Rise

In the age of tightening purse strings, as interest rates soar and investors demand ever-higher returns on capital to compensate for risk, in the months and years ahead we may see a rising tide of venture debt.

Capital, of course, is the lifeblood of any company — but especially so for startup firms, just getting off the ground and coming to market with new products and services. It’s also the lifeblood of relatively better-established companies with at least some presence in their chosen verticals.

In recent months, certainly so far in 2022, the pace of new listings on Wall Street via traditional initial public offerings (IPOs) and SPAC mergers has been muted; stocks have been volatile, to say the least.  Public listings, of course, are one way for firms to garner funding used for corporate purposes, but typically are embraced by companies with at least some operating track record under their proverbial belts.  Traditional venture capital has seen at least some slippage, as Crunchbase reported this month that global venture funding in February of this year was $10 billion lower than it had been in January.

Uncertainty Cools Traditional Conduits

War in Europe, the lingering pandemic, supply chain snarls and inflation are all converging to keep investors a bit cautious — but this opens the door for venture debt.

At a high level, venture debt is a term loan that is offered by lenders – typically non-bank lenders, though banks can and do branch into venture debt through their venture lending operations – to help smaller firms to satisfy their working capital needs. That venture debt, in turn, gives the lenders warrants or equity options, which equate to a percentage of the loan being extended.  The debt can be extended as, among other things, a way to finance equipment or accounts receivable financing.  The loan terms typically range from 12 months to 48 months – companies tap their accounts as needed (without giving up outsized slugs of owner-equity up front).

As reported earlier this month, startup Mercury is offering venture debt. On its site, the company said that it had been building out the offering since June of 2021.  The firm (with initial focus on early stage firms) is targeting $200 million in venture debt extended this year, rising to $1 billion within the next two years.

Elsewhere, as spotlighted here late last year, eCommerce services firm Cart.com teamed up with eCommerce investment firm Clearco to enable digital retailers to access capital financing.  In the mechanics of that relationship, merchants using Cart.com can access Clearco’s services without leaving the Cart.com app, and can tap as much as $10 million in marketing capital within 24 hours.  U.S. FinTech Brex announced its own venture debt offering last year.

For the firms that tap into venture debt, the practice might beg the question: Why tap this vehicle when working capital loans might carry comparatively lower interest rates – and give up some equity in the interim?  The fact remains that the working capital loans tend to be for shorter duration (say, for a year) and are meant to cover some of the day-to-day purchases of inventory, plant and equipment etc.

The venture debt is generally longer term in duration, the financing itself is greater (in terms of the loan size, when compared with what would be offered by banks) and the debt is meant as a complement to the succession of equity rounds that have been tied to the more traditional capital markets (as each round represents a further dilution of managements’ and previous investors’ equity).

Read Also: Cart.com Teams With Clearco For eCommerce Capital Financing

The loans themselves are appealing to firms that may not have the collateral in place that attracts commitments from traditional lenders. And in that sense, amid the uncertainty that has become a hallmark pretty much everywhere, we may see these vehicles gain wider berth in 2022.