By Sarah McBride, Abhinav Ramnarayan, Jill R. Shah and Agatha Cantrill
A key form of financing that startups rely on is shrinking, hurting new companies that are already starved for capital.
The volume of venture debt, a type of loan that younger companies line up to help pay the bills, plunged to $3.5 billion in the US in the first quarter, according to PitchBook, the lowest level since 2017. Climbing interest rates have made the funding more expensive for companies, and one of the biggest venture lenders, Silicon Valley Bank, faced a run on the bank that forced government regulators to seize it and sell it.
First Citizens BancShares Inc., Silicon Valley Bank’s buyer, says its appetite for venture financing hasn’t changed. On a conference call on Wednesday, the company’s president said First Citizens is better positioned to serve venture-backed companies now. But many of the biggest lenders across the economy are less willing to take risk as economic growth slows.
Companies drove venture lending to record levels last year as revenue was under pressure and other forms of financing were drying up. VCs pulled back dramatically on equity investments in the second half of 2022, squeezed by rising interest rates and falling market values across the tech industry. By the first quarter of 2023, venture firms invested $79 billion in startups, less than half the $178 billion a year earlier, according to PitchBook.
Raising equity in public markets is harder too: There were just $2.5 billion of initial public offerings in the US in the first quarter, the lowest for the first three months of the year since 2016, according to data compiled by Bloomberg.
Less debt and equity capital for young companies will probably translate to more companies collapsing, said John Haltiwanger, an economist at the University of Maryland. Startups often aren’t profitable and instead focus on growth, and they need a constant drip of money to keep operating.
“These companies are heavily dependent on financing,” Haltiwanger said. “If that financing dries up, they’re in trouble.”
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Startups’ reduced access to funding has broader implications for the economy. New businesses account for most job creation in the US, Haltiwanger said. Five million such businesses were created last year in the US, according to the Census Bureau.
Debt Alongside Equity
A question mark for many tech industry watchers is the outlook for Silicon Valley Bank’s venture debt business. A spokesman for First Citizens said SVB’s approach to that lending is unchanged.
“SVB is still providing venture debt, along with all of the other credit facilities previously offered,” the spokesman told Bloomberg. “The approach to and appetite for providing credit to technology and life science companies, and investors, has not changed.”
Startups often raise venture debt funding while raising equity. A company might get $20 million of equity in a first round of funding, and Silicon Valley Bank might have offered a $4 million or $5 million line of credit alongside that money, said Kai Tse, co-founder of Structural Capital, which extends loans to late-stage startups. It might have charged around 1 percentage point over the prime rate, while requiring customers to keep their accounts at the bank, helping to boost SVBs deposits and potential fee income.
Other lenders specialized in corporations that were a little older. Generally, the hope was that the line of credit would be repaid when the company sold itself, said Billy Libby, chief executive officer at Upper90, which provides credit and equity to early-stage companies.
While this form of financing has been around for decades, it took on extra importance last year, when the Federal Reserve began tightening rates at the fastest pace in decades to tame inflation. As equity investors have pulled back, it’s unlikely that venture debt lines at younger, largely cash-flow negative companies can get paid back, Libby said.
“It kind of propped up companies that shouldn’t have lived as long as they did,” Libby said. “You’re going to see a reckoning.”
That’s the fear of many venture capitalists and startup companies themselves. Publicly traded tech companies lost nearly a third of their value in the US last year, and even with 2023’s gains are still below their peaks. In the first four months of 2023, US tech companies announced about 114,000 job cuts, on track this year to top the 168,395 announced for all of 2001, the record for the industry, according to Challenger, Gray & Christmas.
‘Know the Companies’
For some privately held startups, the downturn and banking shakeup could make it more difficult to get loans from regular lenders, particularly those without a background dealing with Silicon Valley players. Many lenders are inclined to be increasingly choosy about which companies they finance.
“When you’re in a bull market, it looks like an easy business,” Structural Capital’s Tse said. To price the risk properly, “you have to know the companies, you have to spend time with them, you have to have skills that regular commercial bankers don’t.”
It’s not clear how bad any slowdown in tech lending will be. There are still banks and other firms providing financing. But many lenders take cues from equity fundraising, where valuations are typically unchanged or lower, said Ted Wilson, a former Silicon Valley Bank vice president who joined Stifel Bank in March. That’s making it harder for companies to borrow, he said.
“There are often insider rounds, follow-on rounds, flat rounds,” Wilson said, referring to deals that don’t increase the valuation of a startup or don’t include new investors. “Those are not quite as attractive from a lending perspective.”
‘Shake Out Process’
In Europe, some lenders are trying to increase their market share as rivals cut back, said Matthias Kresser, partner at YPOG, a Berlin-based law firm that advises German tech companies and venture firms. At Germany’s Cherry Ventures, which provides seed funding to startups, partner Christian Meermann said on the weekend SVB was collapsing, he heard from venture debt funds looking to win more business.
If startup companies do find themselves with less access to credit, the economy may ultimately benefit, said Steve Davis, an economist at the University of Chicago Booth School of Business and a senior fellow at the Hoover Insitution. Capital may flow to better startups, and worse ideas may not get money.
“The shake out process is an important force or mechanism through which the economy figures out what works and doesn’t work,” Davis said.
But in the near term, tighter funding conditions could be painful for venture capital-backed companies as they struggle to fund their daily operations.
“There’s going to be a funding crunch in this sector,” said Steve Brotman, founder and managing partner with Alpha Partners, which invests alongside venture capital firms in growing companies. “It’s going to flush out a lot of the excesses in the system.”