Venture Debt Market Conditions

As one of the most active debt advisors to the innovation economy having closed 65 transactions in the past 5 years, we have a unique vantagepoint on market conditions. With the backdrop of Fed tightening, record inflation, pressured public markets and economic uncertainty, we are sharing some insights below.

Overall, the technology / venture lending market is seeing turbulence but holding up well

• Venture backed startups raised $16B of debt during 1H’22 vs $13B same period last year (per Crunchbase data)

• There remains significant supply in the market; lenders remain motivated to (thoughtfully) put capital to work

• Loan loss rates remain healthy and companies are generally carrying healthy cash balances, driven by significant equity raised in 2020 / 2021, and recent opex cuts across the board

• However…equity funding and exit options have reduced dramatically, which may lead to reduced portfolio credit quality, higher loss reserves, and increased losses in the coming quarters

With respect to new loans, the single biggest factor has been the significant reset in equity valuations, creating significant degradation in Loan-to-Value ratios

• Some venture debt portfolios now appear materially over-leveraged; this paired with economic uncertainty has resulted in select lenders stopping all new lending activity in tech, particularly smaller innovation lending groups within larger diversified institutions

• Post term sheet, we have seen an increase in lenders re-visiting terms, reducing quantum offered, or simply walking away

• Existing lenders have been less amenable to covenant resets, creating more pressure for borrowers to re-fi with a new lender partner

Pricing & terms have adjusted, but not dramatically

• Overall: Dislocation of lender risk tolerance – many lenders remain risk-on, while others have gone “risk-off”; this is leading to a wide spreads of terms, structure and pricing for a given opportunity

• Leverage: Lower comp valuations are translating to reduced debt-to-revenue by 20%+

• Rates: Some lenders have increased rate spreads (above SOFR or Prime) creating a double whammy rate increase, while others have held spreads firm

• Covenants: higher min liquidity requirements, more focus on CF positive (or levers to achieve same) over medium term, particularly at the later stages

• Warrants: Select lenders have meaningfully increased warrant coverage, though the market remains splintered here, with most firms making no adjustments at all

Positioning for success (borrowers)

• Keep the pulse of existing lenders; communicate well ahead of potential covenant issues

• Develop a lender plan that is ‘fully funded’ and not reliant on future equity

• Avoid launching a debt raise with less than 6-12 months of liquidity

• Create backup options and be prepared to pivot

• Be wary of long exclusivity periods

• Diligence newer lenders in particular, and their commitment to the sector