Venture debt on the rise

Bryce Bewley from Horizon Technology Finance speaks with NutritionInvestor about the momentum in venture debt financing

By Murielle Gonzalez

What do Clara Foods, BlueNalu, and YourZooki have in common? These three scale-up companies all made headlines this year with multimillion debt financing. In January, US-based Clara Foods, the company developing alternative protein ingredients for food and beverages, secured $8 million through a funding facility with Horizon Technology Finance, and cell-based seafood company BlueNalu raised $60 million in a convertible note round. In February, premium liquid supplements maker YourZooki agreed to a £1.6 million debt financing deal with Metro Bank.

“Venture debt is growth capital in the form of a loan that institutional and venture capital-backed companies use to augment equity capital,” explains Bryce Bewley, venture debt executive at Horizon Technology Finance. He notes venture debt is typically structured as a ‘term loan’ secured by a company’s underlying assets.

Horizon Technology Finance has been providing venture debt to emerging growth technology and life science companies for the past 18 years. Bewley says the venture debt market represents 10-20% of the total venture capital dollars invested.

“According to Pitchbook, in 2020, $27.5 billion was deployed in the form of venture debt in the US,” says Bewley, noting that awareness of venture debt has grown significantly. “As venture capital investment has expanded in recent years, so has the size of the venture debt market.”

Bewley observes a shift in the market has been crucial to the increasing market share of venture debt. “We have seen a bit of a shift from the ‘grow at all costs’ mentality for many start-ups. Companies tend to be more focused on leveraging their capital efficiently and in a less dilutive manner. And companies with these profiles are a great fit for venture lenders.”

Since 2004, Horizon has directly originated and invested more than $2 billion in venture loans into more than 270 companies. The company has successfully managed portfolios through the dot-com bust and global financial crisis, and the Covid-19 pandemic made Horizon more active than usual.

Ventured debt in the Covid-19 era

Not only has the use of venture debt expanded organically, but the impact of the Covid-19 pandemic caused many companies to re-evaluate their capital allocation plans.

“In the early days of the pandemic, there was a lot of uncertainty around what the state of the venture capital market would be when companies started their next fundraise in six-to-18 months. As a result, we saw a number of companies who had not previously considered venture debt turn to it as an option for cash runway extension,” says Bewley.

However, 2020 ended up being a record year for venture capital investment despite the pandemic – global venture funding increased by 4% year-on-year to $300 billion, according to Crunchbase.

For Bewley, venture debt played an important role in the venture ecosystem by providing many companies with the resources to extend their runway and ensure that their valuation at the next fundraise was not artificially deflated as a result of the Covid-19 pandemic. “Today, we are finding that companies are now more familiar with venture debt and have a greater awareness of the value and specific use cases where venture debt can be helpful,” says Bewley.

“Anecdotally, we have seen somewhere between 30% to 40% of venture capital-backed companies leverage venture debt during their lifecycle,” Bewley added. He argues this percentage is likely to increase over time as both entrepreneurs and investors better understand the place venture debt has in a company’s capital stack and continue to leverage it as a non-dilutive capital source.

Capital versus debt

Venture capital involves investors providing funding to a company in exchange for ownership in that company. Venture debt is a loan that companies can leverage to augment their venture capital raises to help get to the next inflexion point.

Bewley says that in most cases, venture debt does not replace a venture capital round but rather is a complement to that raise. He recalls one of Horizon’s entrepreneurs put it succinctly: “venture debt is effectively a pre-emptive draw on a start-up’s next funding round.”

A venture loan commonly consists of an interest-only period, usually of about six-to-24 months, when the company makes interest payments on the amount of debt outstanding, followed by an amortisation period, typically of about 24-to-36 months, when the company makes equal monthly payments of principal plus accrued interest.

Bewley says many venture loan facilities are upsized or refinanced on the heels of an equity raise. “Venture lenders are often underwriting on the ability of portfolio companies to attract future equity financing or to reach profitability,” he adds.

In addition to the interest rate, venture lenders typically receive warrants as part of the consideration for extending a loan. “A warrant permits the holder to purchase the company’s stock at a set price, typically the last price at which the company’s stock was sold,” explains Bewley.

The amount of venture debt a company is able to raise can vary significantly based on the stage of the company, market opportunity, venture capital sponsors, revenue traction and other factors. Bewley says that generally speaking, companies can expect to receive capital ranging from 20-50% of the most recent venture capital round raised.

Venture debt landscape

There is a venture lender out there for companies operating in almost every market and at most every stage. Some lenders focus on specific sectors, while others delineate based upon the stage of the company or size of the debt request.

Bewley notes that, from a timing perspective, venture lenders tend to get involved after a company has raised an institutional round of funding from venture capital investors.

“Venture debt is not a fit for every company and it may not be the right time for venture debt at every lifecycle stage, but venture debt can be valuable in reducing ownership dilution for entrepreneurs and accelerating the growth of companies,” he says. “I always suggest that every company consider if venture debt would be a useful tool for their particular needs.”

The best practice is to talk to multiple players in the venture debt space to understand the market terms for companies in a particular sector. “On numerous occasions, I’ve had entrepreneurs come to me after they have established a deal thinking they got a great offer, only for me to have to break the news to them that we, or another lender, probably could have provided much more compelling terms,” says Bewley.

He notes that addressing venture debt options is like finding a contractor to remodel your house – if you only get one bid, you really don’t know if you are getting the best deal out there, both in terms of price and structure. “Also, make sure your board is supportive and aligned with your proposed use of the debt and the value it will unlock for you,” Bewley concludes.