A Venture Debt Deficit Was Coming, SVB Collapse or Not, Says QED’s Gerety

Silicon Valley Bank (SVB) helped pioneer venture debt as a critical source of alternative financing.

After its untimely failure, many market observers are beginning to wonder — will that source of capital suddenly become more difficult for startups?

“Ultimately, whether Silicon Valley Bank fails or doesn’t fail, what was happening in the environment was a broader recalibration of risk,” Amias Gerety, partner at QED Investors, told PYMNTS CEO Karen Webster. “And that broader recalibration of risk was going to lead to higher prices and lower supply. Period.”

A venture debt deficit was on its way regardless. True enough that Silicon Valley Bank was a big player, Gerety said, and a repeat player who had a lot of faith in the [venture and startup] system. It was also willing to participate in that system on a long-game basis. That said, what’s happening in the venture ecosystem is more about broader macro trends and changes than it is specific to one player not being in the venture debt ecosystem.

Still, he emphasizes that the collapse of a major lender like SVB does chart a straightforward line to creating a deficit, “you lower the supply and increase the demand.”

As reported by PYMNTS, First Citizens Bank, a North Carolina lender with a long history of purchasing failed banks, has assumed ownership of all of Silicon Valley Bank’s (SVB’s) loans and assets.

Whether First Citizens bought SVBs book of business or will buy into their business model remains to be seen.

“I think the jury is out,” Gerety says. “Even if we hear the right signals, it will still be a little bit of time before we really know whether First Citizens is fully embracing the [venture debt] business.”

Recessionary Pressures Highlight Startups’ Need for Cash

Venture debt is a variety of loan product or line of credit typically offered by specialized banks and non-bank lenders to VC-backed companies.

It isn’t cheap. The loan or line of credit comes with specific warrants that give the issuer the right to buy stock at a specific price in the future, and they are generally backed by a startup’s assets. Startups generally use the debt as a bridge financing tool until they are ready to raise another funding round, sell the business or go public.

As the broader macro climate gears up for a recession, small businesses and startups looking for sources of liquidity to backstop operations in the event of unexpected shocks to the business have often found venture debt a

Still, Gerety emphasizes that he always gives his portfolio companies a “very stern warning” about venture debt: Don’t use it as a bridge; use it as an insurance policy. “Although he said it can be good to have venture debt, there needs to be a very serious conversation about how it will help the business get from nonsurvival to survival … It can’t just be a way to avoid hard conversations around operational and cash flow sustainability, it has to be a real ‘break glass in emergency’ kind of dynamic,” he said.

“If a venture debt line is part of your plan to get to the next milestone, you probably don’t have a great plan,” Gerety said. “because then the next equity investor has to pay off that venture debt in most instances — and now startups need to attract more capital that doesn’t help the business because it’s filling a deficit.

Read More: After SVB, Bank Runs and the Capitol Hill Fireworks … Now What?

Startups Running at Deficits

As PYMNTS reported earlier this month, funding to U.S. tech startups plummeted by 55% during the first quarter of 2023, the lowest level in more than a dozen quarters.

That halving of VC capital being deployed is part of the reason why the venture debt landscape’s prospects are now under a post-SVB microscope and the startup community overall under an even closer one.

“Any bad news in 2020 and 2021 was mitigated by abundant capital, Gerety explained, “and in 2022 and 2023, all the good news is being mitigated by capital scarcity — and all the bad news is basically unmitigated.”

Venture debt will, no doubt, be a smaller industry with Silicon Valley Bank no longer a key part of the picture. The key players still in the space will be pickier about the companies they lend to and the rates and the covenants tied to that debt, Gerety said.

Still, Gerety makes sure to emphasize that it’s not “whether you got capital from me, or a lender, or you bootstrapped,” that makes a company great — at the end of the day, success requires having a great product, great growth, a great time, and new ideas that can shape a better future.