Venture Debt Remains Strong Amidst Slowdown in VC Investment

Recently, Mike Lederman, senior managing director in Bridge Bank’s Technology Banking Group, met up with Smart Brevity Studio to discuss why venture debt is available and as strong as ever for companies that are raising equity. 

To read the discussion in its entirety, view the article on Axios or continue below. 

Economic uncertainty has dramatically changed the venture capital landscape, yet venture debt lenders remain a strong partner for many technology startups.

Why it’s important: Technology & Innovation startups have been turning to venture debt amid a slowdown in equity funding. 

• Venture debt can be a valuable financing tool for growing startups in any economic environment, as it provides support to extend their runway while they work on raising another round of venture capital.

Get up to date: Access to equity and debt funding has been tightening since the beginning of 2022, and even more so year-to-date in 2023.

• Venture-capital funding in the U.S. almost halved in the first six months of 2023; compared to 2022, according to Pitchbook.
• Last year, U.S. venture-capital funding dropped to $238 billion from $345 billion in 2021, according to Pitchbook and the National Association of Venture Capital.

The number of startups raising equity is lower than it has been over the past few years, which will naturally decrease the number of qualified venture debt borrowers.

The reason: Venture debt is not designed to replace equity but rather as a supplement to equity, providing a runway extension between equity rounds.

• If a company is not raising equity from institutional VCs, then it’s not really a venture debt candidate since the lenders depend on investor support as a key component of their underwriting analysis.

Okay, but: Venture debt is available and as strong as ever for companies that are raising equity, says Mike Lederman, senior managing director in Bridge Bank’s Technology Banking Group.

• The number of lenders in the market have increased, bringing on more competition and therefore a lot more options for borrowers. 

Here’s the deal: Tech companies should be more thoughtful and do their research as they decide where to move their banking or obtain funding. 

A lot of startups have been focused on venture debt from non-bank lenders to avoid a bank lender’s primary deposit relationship requirements, explains Lederman.

However, working with a diversified, balanced banking solutions provider can prove to be beneficial in good times and even more crucial in challenging times.

• Here’s why: Many banks offer the Insured Cash Sweep product, meaning companies would have 100% FDIC insurance on the cash that is deposited in that bank.
• If there was an issue with the bank, and it went into FDIC receivership, 100% of the money deposited in the bank is available the following business day. 

What you need to know: Companies that choose stable, relationship-oriented banking partners will be stronger.

When looking to partner with a lender, startups need to ask themselves three crucial questions: 

1. Who is the lender and do they have experience lending to startups? 

• A lot of new lenders often enter the market only to leave within a couple of years because they didn’t have full alignment at all levels, including the regulator, executive management, credit and the frontline. 
• Banks that have been in the market for 20 years and have gone through multiple cycles can often prove they have alignment at all levels providing a bit more security to borrowers. 

2. What will the partnership look like?  

• Borrowers should ensure that they’ll be working with someone who is going to advocate for them on a day-to-day basis. 
• Having the same point of contact throughout all stages of a company’s life cycle leads to better solutions and a stronger partnership. 

3. Who is going to give you the best loan terms? 

• Finally, startups must ensure they take a close look at a lender’s terms to ensure they’re getting a competitive deal that sets them up for success. 

The positive news: Bridge Bank has been providing competitive venture debt options to its clients and prospects while being a partner in good times and bad for more than 20 years. 

The bank aims to be more than a lender to its borrower. They want to be a resource to their clients by regularly making connections to investors that might be interested in working with the companies who are looking to raise equity.  

Here’s what else: As companies continue to navigate this uncertain environment, Bridge Bank remains proactive and open to working with their clients on a case-by-case basis to discuss refinancing options. 

Some examples: 

For one client, Bridge Bank proactively extended the interest-only period to allow more time for a series A company to raise their series B before the amortization began. 

• The result: The borrower is confident in their ability to close this round even though it’s taking longer than they thought, but now they get to save capital in the near term via delayed principal payments. 

In another example, Bridge Bank was able to modify the covenant structure for a later-stage company that was not increasing revenue at the rate they originally projected.  

• The result: Bridge Bank and the Borrower agreed on a revised loan structure that enabled the company to maintain compliance with the new covenant which more closely aligned with the company’s updated forecast.

The takeaway: “Access to capital is more important today than it’s been over the last number of years,” says Lederman. “With the uncertain equity environment, venture debt is a great way to help extend that runway and validate the business model to obtain more equity later at a higher value.”