Startups borrowed so they didn’t have to give up equity. After the collapse of market leader SVB, they should expect higher rates and fewer agreements in the near future.
Iin 2017, when David Rabie first launched Tovala, which pairs a smart oven with a food delivery service, the idea seemed a little crazy. Then came the pandemic and the idea took off. He has raised about $100 million for the Chicago-based business, and has also borrowed a few million dollars in venture debt from Silicon Valley Bank as an alternative to selling parts of the company. That allowed him to expand Tovala, which now employs 350 and has three food facilities in Illinois and Utah.
“SVB lent us money when the business was deeply unprofitable and in an early phase,” says Rabie Forbes. “A lot would have been different if SVB had not lent 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 raised venture debt from Silicon Valley Bank — the failed bank that was its largest issuer — as debt financing for venture-backed startups grew. The use of venture 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 share of the issue last year was USD 6.7 billion. Rates ranged from 7% to 12%, plus warrants that enabled the lender to obtain a small stake in the business.
Since the collapse of Silicon Valley Bank last weekend, founders and investors have raised many questions about what might happen to their existing debt. As panic spread during the run of the bank, entrepreneurs who had taken out venture debt with SVB worried that if they took their money out of the bank, they could breach the loan terms requiring them to keep cash there. Now some are wondering who might buy the debt — private equity firms including Apollo Global Management have been reported to be interested — and ultimately end up with a minority stake in their businesses. “It’s kind of uncomfortable that you’re sending investor updates to a mystery player,” says Matt Michaelson, founder and CEO of Smalls, a high-end cat food startup that took on venture debt with SVB.
More broadly, there is the question of what happens to this market, which had grown rapidly but largely under the radar, at a time of rising interest rates and investor churn. “Venture debt is going to be more expensive,” says Jeff Housenbold, the former CEO of Shutterfly and a SoftBank venture capitalist who now runs his own investment firm, Honor Ventures. “Companies that are fragile will not be able to take on debt.”
On Tuesday, Tim Mayopoulos, the new CEO of Silicon Valley Bridge Bank, the name of the entity operating under FDIC receivership, said in a memo that the bank would “make new loans and fully honor existing credit facilities.”
It quelled some immediate concerns, but it doesn’t answer the long-term questions.
To understand how cheap this money once was, consider the case of Rajat Bhageria, founder and CEO of Chef Robotics. He took out a $2 million debt facility with SVB in December 2021 at an interest rate of just 50 percentage points above prime, which was then 3.25%—an extraordinarily low cost of capital for a robotics startup. “Obviously prime has changed quite a bit,” he says. “At that point it was extraordinarily low and it was like, ‘How on earth are we going to pull this off?’
For a robotics company, where the cost of capital is high, the venture debt helped a lot, and Bhageria still sees it as positive even though the prime rate has risen to 7.75%, increasing his borrowing costs. “There are a lot of complaints about subprime debt,” he says. “They market it as a ‘runway extension’ – the time the business can continue to operate without raising new funds – ‘but that’s not entirely true because you’ll very quickly have large debt payments per month.’
Michaelson, the cat food CEO, has raised about $30 million in equity and has a $4 million debt facility with SVB. He says he is reassessing the company’s financing in the wake of SVB’s failure. When the bank run began, he says, “we got a lot of pressure from our investors to get our money out.” But he was worried that the loans would be defaulted. When he finally tried to withdraw money, the transfers failed due to the increasing demand. Although it is now in the past, the experience has made him think again.
“I worry,” he says. “We talk about ‘Do we refinance the debt elsewhere?’ The question is what is the debt market doing and will there be debt like this available? The wind is blowing towards less available debt, and people who are less likely to get that debt are likely to feel the squeeze.”
Michaelson says he recently heard of a founder with a similar startup who got a term listing for venture debt at a 13.5% interest rate. “It’s much higher than what we’re looking at,” he says. “At a certain interest rate, it ceases to be as attractive. You’re not just comparing debt to debt, but debt to equity. Depending on how valuations move in the venture markets, it becomes less competitive.”
Since SVB’s collapse, non-bank lenders have been looking to gain more market share in the venture debt market. “Even though SVB had 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 question for the future, as always when it comes to financing, is risk and cost. “It’s expensive right now because people are risk averse,” says Housenbold. “So there will be less venture debt early on, which means founders are going to take more dilution. The venture capitalists are going to make more money, and the founders are going to own less of the company.”