There is a lot about venture capital’s reset and new normal that was predictable.
The modern role of venture debt was not one of them. In fact, as of SVB’s failure in March 2023, many thought venture debt would see an accelerated demise. Not only were startups getting riskier with equity and customer dollars tight (and yet often still high burn rates), but now the industry’s leading creditor was on the rocks.
As 2024 wraps up, we see the opposite has happened. The chart below shows that venture debt dollars invested are on track for a near record high after a slump that mirrored equity in 2022 and 2023. Yet equity remains near lows.
Source: Pitchbook; 2024 data extrapolated from YTD Q3 totals; $7.5B CoreWeave debt outlier is excluded in 2024.
There are a few hypotheses that could explain this. SVB - the reincarnated one - points to the increasing cost of equity capital as an explanation. Hmmm, shouldn’t debt be getting more expensive too, though? Foundational interest rates are up, and venture forward banks are somewhat less awash in deposits to lend.
Perhaps startups are, in fact, getting less risky. Many are burning less, approaching cash flow positive or even profitable. Maybe because founders and execs are running startups more efficiently and (dare I say) responsibly, lenders perceive them as being less risky. This despite less overall liquidity in the market.
As usual, I think the answer depends.
When I saw the chart above, the question I had was to what extent the role of debt was changing in the different stages of the capital stack. One way to think about this is in terms of a debt to equity deployment ratio by stage. For example, in 2021 there was $41B of venture debt and $353B of venture equity deployed in the US. This equates to an 11.6% ratio for all stages as shown on the dotted black line plotted below.
This chart shows the significantly evolving role of venture debt in different stages of venture investing. At a high level first, debt has become an increasingly important part of the overal capital stack over the last decade, increasing from just above a 10% ratio in 2014 to above 20% in 2024, though this trend was “crowded out” by the 2021 and 2022 equity explosion.
Interestingly, though, the real changes over time are visible in the Early-stage and Venture Growth stages. (Aside: Pitchbook defines “Venture Growth… as any financing that is Series E or later or any VC financing of a company that is at least seven years old and has raised at least six VC rounds”).
In “early stage”, which includes A and B, we seem to see the opposite of the “startups are less risky now” hypothesis. Venture lenders seem to be consistently moving away from Early Stage after increasing participation through the 2010s and market peak. The opposite is true of Venture Growth, where lenders are loading up… or maybe we should say Venture Growth companies are loading up on debt.
In yesteryear’s parlance, Venture Growth might also be referred to as “pre-IPO”. IPOs are rare now, so equity has moved away, yet many of these companies still want capital to grow. They may also be upside-down on their equity valuations while facing reticence from pre-IPO equity investors who prefer a quick flip and don’t see a clear path to one yet. That’s where debt steps in. Lenders see proven business models, near or at cash flow breakeven with low implied Loan-To-Value ratios given these Venture Growth companies are quite valuable. At the same time companies can take the debt at relatively low cost without resetting a valuation or cap table. Win-win.
We don’t see a lot of change over time in Pre-seed/Seed and Late-stage.
It doesn’t feel likely this will last. When markets get more liquid, equity is likely to pile into Venture Growth companies, which may crowd out venture debt. In the meantime, it has served as a very helpful stopgap for quality companies, whom for now must owe to grow.
