Investments in venture capital debt are expected to increase
In an era of tighter purse strings, as interest rates soar and investors demand ever-higher returns on capital to offset risk, in the months and years ahead, we could see a rising tide of risky debt.
Capital, of course, is the lifeblood of any business – but especially for start-ups, which are just getting started and coming to market with new products and services. It is also the lifeblood of relatively more established businesses with at least some presence in their chosen verticals.
In recent months, certainly so far into 2022, the pace of new listings on Wall Street via traditional initial public offerings (IPOs) and SPAC mergers has been slowed; stocks have been volatile, to say the least. Public listings, of course, are a way for companies to raise funds used for trading purposes, but they are generally adopted by companies with at least some operating history to their credit. Traditional venture capital has seen at least some slippage, as Crunchbase reported this month that global venture capital funding in February this year was $10 billion lower than it was in January. .
Uncertainty chills traditional conduits
The war in Europe, the lingering pandemic, supply chain issues and inflation are all converging to keep investors a little cautious – but that opens the door to risky debt.
At a high level, venture capital debt is a term loan offered by lenders – usually non-bank lenders, although banks may get into venture capital debt through their lending operations. risk – to help small businesses meet their working capital needs. This risky debt, in turn, gives the lenders warrants or stock options, which is equivalent to a percentage of the loan granted. Debt can be extended as, among other things, a means of financing equipment or financing accounts receivable. Loan terms typically range from 12 months to 48 months – businesses draw from their accounts as needed (without giving up inordinate amounts of owner’s equity up front).
As reported earlier this month, startup Mercury is offering venture capital debt. On his site, the company said it has been developing the offering since June 2021. The company (with an initial focus on early-stage companies) is targeting $200 million in extended venture debt this year, which will grow to $1 billion. dollars over the next two years.
Elsewhere, as highlighted here late last year, e-commerce services company Cart.com has teamed up with e-commerce investment firm Clearco to give digital retailers access to the capital funding. Within the mechanics of this relationship, merchants using Cart.com can access Clearco’s services without leaving the Cart.com application and can leverage up to $10 million in marketing capital within 24 hours. US FinTech Brex has announced its own supply of risky debt last year.
For companies tapping into venture capital debt, the practice could raise the question: why exploit this vehicle when working capital loans could carry comparatively lower interest rates – and forgo equity in the interval? The fact remains that working capital loans tend to be of shorter duration (say, for a year) and are meant to cover some of the day-to-day purchases of inventory, plant and equipment, etc.
Venture capital debt is usually of longer duration, the funding itself is larger (in terms of loan size, compared to what would be offered by banks) and the debt is designed as an add-on to the succession of funding rounds that have been linked to more traditional capital markets (each round representing a further dilution of the equity of managers and previous investors).
Also Read: Cart.com Partners with Clearco for Ecommerce Capital Funding
The loans themselves are attractive to businesses who may not have the collateral in place that attracts commitments from traditional lenders. And in that sense, amid the uncertainty that has become a feature pretty much everywhere, we could see these vehicles gaining a wider prominence in 2022.