In this post, we will explore the current state of the venture debt market and how macroeconomic factors may impact its growth in the coming year.
Macro Outlook for venture debt.
2023 is shaping up to be a year of economic uncertainty, with a variety of factors potentially impacting global growth. According to Goldman Sachs, we can expect global growth to slow to just 1.8% in 2023 due to a combination of factors such as diminishing reopening boosts, fiscal and monetary tightening, and ongoing conflicts such as the Russia-Ukraine war. In the US, however, the picture may be slightly rosier. Goldman Sachs predicts that the US will narrowly avoid a recession and that the Federal Reserve will hike interest rates by an additional 125bp, reaching a peak of 5-5.25%.
Optimism in 2023
Rising interest rates and market volatility have caused equity funding to become less readily available than in previous years. For startups looking to extend their runways without risking their valuations, venture debt seems to be a natural choice, especially because it is cheaper than equity. Venture debt provides an alternative option for startups looking to raise capital while maintaining control over their company. Unlike traditional venture capital, venture debt requires startups to pay back the principal and interest on the loan, usually over a term of three years. Peter Thiel, the co-founder of PayPal and former board member of Facebook, is among the investors betting on the growth of the venture debt market. In December, Bloomberg reported that Thiel invested in Tacora Capital, a venture-debt fund, making him the latest and highest-profile mainstream investor to invest in this sector of the industry. Data from PitchBook shows that venture debt in the US reached $26.5 billion in value at the end of November, with the second quarter of 2022 being the second-largest quarter in terms of debt value in the past decade.
Risks to growth in 2023
Despite this relatively optimistic outlook, there are still potential risks on the horizon. While venture debt can be a useful tool for startups looking to extend their runways without risking their valuations, there are concerns that the risks of this type of lending are being overlooked, particularly in the current economic climate. Unlike equity funding, venture debt must be repaid, and if a startup defaults on the repayment terms or covenants, the consequences can be severe. If a startup defaults on its venture debt, the loan becomes due and payable immediately. Lenders may also increase interest rates or revoke access to additional credit, and in rare cases, may even force a company to liquidate or be sold if they are unable to meet their repayment obligations. With the current economic downturn making it more challenging for startups to achieve required growth rates or meet other performance-related metrics, the risk of default is higher, leading some venture lenders to include stricter covenants in their loans. It is important for startups to carefully consider their ability to meet the terms of their venture debt before taking it on and to communicate openly with their lender if they anticipate any challenges in meeting their obligations.
Here’s a tweet from Jason Calacanis that sums this up well.
Overall, the venture debt market in 2023 looks to be a promising opportunity for startups seeking to succeed in an uncertain economic environment. However, it is essential for startups to carefully assess their ability to meet the terms of their venture debt and communicate openly with their lender if they foresee any challenges in meeting their obligations. With the right planning and management, startups can use venture debt as a valuable alternative source of capital to achieve their growth goals.
To aid in this process, startups can utilize FundStory, a platform that helps finance teams effectively allocate debt capital and make better financial decisions by providing them with the tools to analyze risks, manage investments, and explore different scenarios. By using FundStory, startups can make more informed decisions about their venture debt and effectively manage their capital to achieve their desired growth.