In Wake of SVB Collapse, Venture Lending Faces Uncertainty

By Lori Ioannou, Wall Street Journal • April 8, 2023

The demise of Silicon Valley Bank was a shock for the $32 billion venture-debt industry, a critical source of alternative financing for startup companies.

Since its inception, SVB had been a pioneer in the venture-debt field, and a linchpin for venture-backed startups looking for capital to expand their businesses. Last year, SVB had $6.7 billion outstanding in venture loans, according to PitchBook-NVCA Monitor. Now, many are wondering what SVB’s demise will mean for the venture-debt market.

The Federal Deposit Insurance Corp., which took control of the lender it now calls Silicon Valley Bridge Bank, sold substantially all of its loans, deposits and branches to First Citizens BancShares Inc. in March. The loans were sold at a discount. As of April 3, some $90 billion in SVB’s securities and other assets remained in receivership. Some see the tumult as an opportunity.

“First Citizens has bought the greatest footprint in the tech innovation hub of America,” says David Spreng, chairman and CEO of Runway Growth Capital, a venture-debt lender that focuses on late-stage startups. “SVB didn’t fail because it had bad loans; it failed because it had bad assets.”

Now market watchers are waiting to see how active First Citizens will be in venture lending in the months ahead as it integrates SVB’s assets and operations into its own bank. An FDIC spokesman verified Silicon Valley Bridge Bank’s venture loans were part of the loan portfolio acquired by First Citizens.

According to Peter Bristow, president of First Citizens Bank, “Silicon Valley Bank will continue to be a leader in providing venture debt to technology and life-sciences companies as a division of First Citizens. We are enthusiastic about this part of our business.” He says the SVB venture-debt team has been onboarded as employees of First Citizens Bank.

Where will it end?

Another unknown is how skittish other bank venture lenders will be as they focus on risk management in the wake of SVB’s failure. “I think you’ll see a tightening of funding as some regional banks pull back a bit,” says Brian Wayne, director of Aegon Asset Management’s Impact Venture Credit Program, which provides venture debt to climate-tech startups.

“We are in the early days of the SVB fallout, and where it all ends is not clear,” says Troy Zander, partner of Barnes & Thornburg’s San Diego office who leads its venture-debt practice. “That’s why many founders who raised venture debt from SVB are now out looking for replacement venture-debt providers that will refinance these loans.”

Some are turning to other regional banks that specialize in providing venture debt—such as Comerica, Western Alliance Bank and East West Bank—as well as J.P. Morgan’s Innovation Economy Debt Solutions business. Others are tapping nonbank lenders such as Hercules Capital, Horizon Technology Finance and Trinity Capital along with new lenders such as Applied Real Intelligence, or ARI.

“I am seeing 10 times more demand since SVB’s blowup,” says Zack Ellison, ARI’s managing general partner and chief investment officer, who is currently seeking investors for the company’s ARI Venture Debt Opportunities Fund. Mr. Ellison says he expects the fund will total $125 million when it closes by year’s end.

Mechanics of venture debt

Unlike traditional bank financing, venture debt is a loan or line of credit with warrants—rights to buy stock at a specific price in the future. It is often backed by a startup’s assets. It is typically offered by specialized banks or nonbank lenders to help fast-growing venture- capital-backed companies get bridge financing until they are ready to raise another round of venture capital, or sell or go public.

Venture loans are most often structured as three- to four-year term loans with an interest-only period of six months to two years. They typically then amortize over the remainder of the Term.

“Up until now, interest rates on these have been based on the prime rate,” currently 8%, says Mr. Ellison—plus, he says, a credit spread that typically could be up to 4 percentage points above that from a bank and 6 to 8 points from a nonbank lender.

While that has been the rule of thumb, Mr. Spreng says warrant coverage can sometimes be much higher on early-stage deals. He also notes that some lenders including Runway Growth often base these loans on the Secured Overnight Financing Rate, the cost of borrowing cash overnight using Treasury securities as collateral, instead of the prime rate.

Over the past 15 months, demand for financing in the form of venture debt has boomed as venture capitalists have tightened their purse strings. Venture-capital funding in the U.S. fell 29% to $245 billion in 2022 from $345 billion in 2021. Startups looking to shore up working capital ahead of a possible recession have found venture debt a lifeline.

The drop in private-company valuations has also been a driver in the surge of demand for venture debt. According to Kyle Stanford, a senior venture-capital analyst at PitchBook, the median valuations for early-stage startups has fallen 17% since 2021, and it has declined 65% for late-stage, “venture growth” pre-IPO companies.

The trend has meant that startups must give up more equity in exchange for venture capital, and many founders don’t want that equity ownership dilution. That’s what prodded Gary Mittman, founder and CEO of KERV Interactive, an interactive video company powered by AI to turn to Trinity Capital for $4.5 million in venture debt last October. “Since the SVB collapse, many venture-debt lenders have been aggressively pitching me for business every day,” Mr. Mittman says.

The next worry

As private lenders rush in to fill the void in the market, many worry that venture-debt packages will become more expensive and have more onerous terms. “Private-equity firms usually offer venture loans with higher interest rates and often ask for more equity warrant coverage than a bank,” says Jay Jung, managing partner of Embarc Advisors, a strategic finance advisory for startups and small and medium-size businesses in San Francisco.

But how all of this will play out is unknown, especially as interest rates rise and lenders become more risk averse. ARI’s Mr. Ellison says of the current situation: “It’s like throwing sand in the gears of a machine: Even if the wheels keep turning, it will be a harder process for startups to raise money.”

Read the original Wall Street Journal article here.

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