Venture debt fit to outpace wider VC market

The sector is on track to outpace the wider VC market, according to a recent PitchBook report. But as interest rates remain low, venture debt could become just as popular as equity in VC.

Venture debt is growing faster than traditional equity financing and faster than the wider VC market, according to a recent PitchBook report titled Venture Debt a Maturing Market in VC.

Venture debt’s rise as pillar of the market has largely coincided with the growth of private markets generally. US venture deal counts have grown from roughly 5,500 deals in 2010 to 12,250 in 2020 (2.22x) and US PE deal count has expanded from 2,760 in 2010 to 5,300 last year (1.92x), the report said.

But venture debt as a strategy has increased faster than both, going from 940 loans in 2010 to 2,900 in 2020 (3.10x).

It thus “makes sense that the growth of venture debt has outpaced the broader VC market,” the report noted. “More companies receiving institutional venture backing equals more potential borrowers for lenders, in many ways making venture debt a dependent variable.”

But the growth in venture debt, as well as the overall growth in loan value over the years, has, at least partially, been driven by large deals. In 2020, 37 loans accounted for nearly $17 billion in venture debt value, roughly 60.5 percent of the market total for 2020.

Venture debt has, up until this point, largely been viewed as a tool for adding last-minute growth capital without handing over any additional equity rights, but the debt market has grown to be used in a variety of ways. WeWork received emergency funding in the form of debt from SoftBank, with other high-profile companies Bumble and DoorDash using debt as well.

Before finalizing its IPO in 2019, Uber raised more than $4 billion across several instruments, including debt. Airbnb famously garnered considerable attention for its $1 billion loan from Silver Lake Partners, not necessarily for its size, but for the post-IPO windfall Silver Lake received from the attached warrants, emphasizing the different ways even big high-profile companies and established VC managers are increasingly using debt.

Stage growth

The PitchBook report claimed venture debt has been split evenly between early- and late-stage companies over the last decade in terms of financing count. But PitchBook’s methodology treats convertible loans as venture debt, which is hugely popular in the early-stage.

“Recently, even seed-stage loans have caught up [to late stage], largely because of the increased use of convertible notes for these investments,” the report said.

David Spreng, Runway Growth Capital

The convertible loans that are widely popular in early-stage are mainly Simple Agreement for Future Equity (SAFEs), according to David Spreng, chairman and chief executive of Runway Growth Capital, a venture debt manager with $857 million in loan and other originations.

“Many, if not most of the really early-stage debt deals that were covered by PitchBook are actually seed financings that are structured as SAFEs,” he told Venture Capital Journal.

SAFEs are a way to enable a company to start raising capital without having to go through all the expenses of doing a full-blown Series A, according to Spreng. The cash the company receives in the form of a SAFE then gets converted to equity, typically with a cap.

That has an effect on wider deal value figures, as the average loan size of $1 million stated in the report may be a lower than reality, Spreng said, as his firm’s average loan size is around $30 million.

While not necessarily equal to the popularity of late-stage debt financing, early-stage is continuing to grow, highlighting the growing mix of financing options now widely available in venture debt.