This short piece highlights the intersection of venture debt funds and middle market debt funds, and key differences in their approaches. Thank you to Mike Standlee and Matt Schwartz of DLA Piper's Venture and Growth Lending team for their insightful contributions.
During the pandemic, most of the tech sector has not only held up well but thrived, further enhancing the sector’s relative "credit" quality. This performance along with higher yields offered by the sector will likely accelerate the trend of traditionally middle-market focused debt funds delving into venture lending, particularly at the later stages.
Of course, the underwriting DNA and the overall playbook of middle-market debt funds, many of whom originate from larger pools of capital based in international money centers, are different from those of traditional venture debt funds.
Middle-market lenders generally place more emphasis on company fundamentals, sector dynamics, and underlying unit economics and profitability, and less on equity investor support. Additionally, these lenders can employ more creative structuring, offering more usable capital and longer term holds.
However, this can come with costs. To name a few: multi-faceted covenant packages that may not align with sometimes jagged and cash-hungry growth trajectories, a higher-friction closing process with extensive credit agreements and third-party consultants, and other factors highlighted below.
In our view, there remains a meaningful gap in styles, underwriting approach, and transaction costs.
In the chart below, we set out some of the most significant differences between middle-market and venture debt funds.
Middle-market debt funds can offer more “usable capital” via larger commitment sizes and patient repayment schedules, however “learning curve” still meaningful when playing in venture
Emphasis on cash-flow covenants and other governance requirements may not fully align with venture-stage companies
Diligence and closing process may be perceived as higher friction; loan documentation and related costs may lead to borrower sticker shock
Companies should understand a lender’s DNA and commitment to the venture sector to mitigate surprises, both during the closing process and post-closing