Startups took out loans so they didn’t have to give up equity. After the collapse of the market leader SVB, they should expect higher rates and less business in the near future.
In 2017, When David Rabie first launched Tovala, which combines a smart oven with a food delivery service, the idea seemed a little crazy. Then came the pandemic and the idea took off. He raised around $100 million for the Chicago-based business, and also borrowed a few million dollars in distressed debt from Silicon Valley Bank as an alternative to selling parts of the company. This has allowed him to expand Tovala, which now employs 350 people and has three catering facilities in Illinois and Utah.
“SVB lent us money when the business was unprofitable and in its early stages,” Rabie says. Forbes. “A lot would have been different if SVB hadn’t loaned us the money in Serie A. [venture-funding round]. There were no other banks willing to do that.”
Rabie is just one of many entrepreneurs who have taken on venture debt from Silicon Valley Bank — the failed bank that was its biggest issuer — as debt financing for venture-backed startups grew. The use of risky debt reached $32 billion in 2022, a more than fourfold increase from $7.5 billion in 2012, according to the Pitchbook-NVCA Monitor. SVB’s participation in this issue last year was US$ 6.7 billion. Their rates ranged from 7% to 12%, plus guarantees that allowed the lender to obtain a small equity stake in the business.
Since the collapse of Silicon Valley Bank this past weekend, founders and investors have raised many questions about what might happen to their existing debt. As panic spread during the run on the bank, founders who had taken on bad debt with the SVB feared that if they withdrew their money from the bank, they might be violating the loan clauses that obliged them to keep the money there. Now some are wondering who could buy the debt – private equity firms including Apollo Global Management would be interested – and ultimately end up with a minority stake in their business. “It’s a little uncomfortable that you’re sending investor updates to a mystery player,” says Matt Michaelson, founder and CEO of Smalls, a cat food startup that has taken on venture debt with SVB.
More broadly, there is the question of what happens to this market, which has been growing rapidly but largely under the radar at a time of rising interest rates and investor jitters. “Venture debt is going to be more expensive,” says Jeff Housenbold, the former CEO of Shutterfly and a venture capitalist at SoftBank who now runs his own investment firm, Honor Ventures. “Companies that are fragile will not be able to contract debt.”
On Tuesday, Tim Mayopoulos, the new CEO of Silicon Valley Bridge Bank, the name of the entity that operates under the administration of the FDIC, said in a memo that the bank would be “making new loans and fully honoring existing lines of credit.” .
That allayed some immediate concerns, but it doesn’t answer the long-term questions.
To understand how cheap that money once was, consider the case of Rajat Bhageria, founder and CEO of Chef Robotics. He took out a $2 million line of credit with SVB in December 2021 at an interest rate just 50 percentage points above prime, which at the time was 3.25% – an extraordinarily low cost of capital for a startup. of robotics. “Obviously prime has changed a lot,” he says. “At that point, it was extraordinarily low, and it was like, ‘How the hell are we getting this?’”
For a robotics company, where capital costs are high, the venture’s debt has helped a lot, and Bhageria still sees it as a positive, even as the prime rate has risen to 7.75%, raising its borrowing costs. “There are a lot of complaints about enterprise debt,” he says. “They market it as a ‘runway extension’” – the time the business can continue to operate without raising new funds – “but it’s not entirely true because very quickly you’re going to have big monthly debt service payments”.
Michaelson, the cat food CEO, has raised about $30 million in equity and has a $4 million line of credit with SVB. He says he is rethinking his company’s funding after the SVB crash. When the run on the banks started, he says, “we were getting a lot of pressure from our investors to withdraw our money.” But he feared the loans would default. When he finally tried to withdraw the money, the transfers failed due to increased demand. Although that is in the past, the experience has made him rethink.
“I worry,” he says. “We talk about, ‘Do we refinance debt elsewhere?’ The question is what does the debt market do and will there be debt like this available? The wind is blowing toward less available debt, and the people least likely to get that debt are likely to feel the pinch.”
Michaelson says he recently heard of a founder with a similarly staged startup who got a term sheet for junk debt at an interest rate of 13.5%. “That’s a lot higher than what we’re seeing,” he says. “At a certain interest rate, it stops being so attractive. You’re not just comparing debt to debt, but debt to equity. Depending on how valuations move in risk markets, it becomes less competitive.”
Since the collapse of the SVB, non-bank lenders have been looking to capture more market share in the substandard debt market. “While SVB has a concentration of startups, it wasn’t so concentrated that you couldn’t find an alternative somewhere,” says Arjun Kapur, managing partner of Forecast Labs, a startup studio that is part of Comcast NBCUniversal.
The big issue for the future, as always when it comes to financing, is risk and cost. “It’s expensive now because people are risk averse,” says Housenbold. “So there will be less risky debt up front, which means founders will have more dilution. The venture capitalists will make more money and the founders will own less of the company.”