Failed Silicon Valley Bank was the largest issuer of venture debt for startups.
Los Angeles Times via Getty Images
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 deals in the near future.
In 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’s raised around $100 million for the Chicago-based business, and also borrowed a few million dollars in venture debt from Silicon Valley Bank as an alternative to selling pieces 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 early stage,” Rabie tells Forbes. “A lot would have been different if SVB had not lent us the money at the Series A [venture-funding round]. There were not other banks willing to do that.”
Rabie is just one of many entrepreneurs who took out venture debt from Silicon Valley Bank — the failed bank that was the largest issuer of it — as debt financing for venture-backed startups grew. The use of venture debt reached $32 billion in 2022, a more than four-fold increase from $7.5 billion in 2012, according to the Pitchbook-NVCA Monitor. SVB’s share of that issuance last year was $6.7 billion. Its rates ranged from 7% to 12%, plus warrants that allowed the lender to gain a small equity 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 on the bank, founders who’d taken out venture debt with SVB worried that if they took their money out of the bank they could be in violation of loan covenants requiring them to keep cash there. Now some wonder who might buy the debt — private-equity firms including Apollo Global Management have been reported to be interested — and ultimately wind up with a minority stake in their businesses. “It’s a little 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’s the question of what happens to this market, which had been rapidly growing but largely under the radar, at a time of rising interest rates and investor skittishness. “Venture debt is going to get more expensive,” says Jeff Housenbold, former CEO of Shutterfly and a venture capitalist at SoftBank who now runs his own investment firm, Honor Ventures. “Companies that are fragile are not going to be able to raise 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 be “making new loans and fully honoring existing credit facilities.”
That allayed some immediate concerns, but it doesn’t answer the longer-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 in the world are we getting this?’”
For a robotics company, where the capital costs are high, the venture debt helped a lot, and Bhageria still views it as a positive even as the prime rate has risen to 7.75%, increasing his borrowing costs. “There are a lot of complaints about venture debt,” he says. “They market it as a ‘runway extension’” — the time the business can keep operating without raising new funds — “but it’s not totally true because very quickly you’re going to have big debt-service 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’s rethinking his company’s financing in the wake of SVB’s failure. When the bank run began, he says, “we were getting a lot of pressure from our investors to take our money out.” But he worried that the loans would be in default. When he finally tried to get cash out, the transfers failed due to the surge in demand. Though that’s now in the past, the experience has caused him to rethink.
“I do worry,” he says. “We talk about, ‘Do we refinance the debt elsewhere?’ The question is what does the debt market do and will there be debt like this available? The wind is blowing towards less debt available, and the people less likely to get that debt will probably feel the squeeze.”
Michaelson says he recently heard of a founder with a similar-stage startup who got a term sheet for venture debt at a 13.5% interest rate. “That’s way higher than what we’re looking at,” he says. “At a certain interest rate, it stops being as attractive. You’re not just comparing debt to debt, but debt to equity. Depending how valuations move in the venture markets, it becomes less competitive.”
Since SVB’s collapse, non-bank lenders have been looking to grab more market share in the venture-debt market. “While SVB did have a concentration of startups, it wasn’t so concentrated that you couldn’t find an alternative somewhere,” says Arjun Kapur, managing partner at Forecast Labs, a startup studio that’s 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,” Housenbold says. “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 will own less of the company.”
