Call it the great reset. Even before the blowups of Silicon Valley Bank and other venture banking heavyweights earlier this year, the venture market – especially the market for debt deals under $5 million – was primed for a cleansing.
And it appears that among those who stand to “clean up” are the publicly traded business development companies such as Hercules Capital, Runway Growth Capital and Monroe Capital’s recently acquired Horizon Technology Finance Corp, as well as other nimble lenders targeting loans of under $20 million.
The regional banking crisis precipitated by the turmoil that started with SVB in March must be seen in a larger context – as an accelerant of a mega-trend towards non-bank lenders that many say began with the global financial crisis.
But SVB’s bankruptcy had less to do with bad loans and more with its position in the venture ecosystem. “SVB was literally the commercial banker to the venture and growth world,” says Dan Zwirn, chief executive officer and chief investment officer of institutional asset manager Arena Investors. “They didn’t take credit risk. They were a victim or party to this overall implosion of the venture growth space.”
That space is being constrained by a moribund market for mergers and acquisitions and initial public offerings, which are inhibiting funds’ exits, alongside a collapse in valuations and funding for technology and biotech companies, to say nothing of increased recessionary pressures. This in turn has resulted in down rounds and restructurings for growth companies. All of which affects venture lending.
“A tremendous amount of capital was invested at unprecedented and inflated valuations and now the recalibration pain is greater in current rounds than in past cycles because of the deflation from the top of Mount Olympus to sea level,” says Michael Gray, a partner who specialises in venture investments at Chicago law firm Neal, Gerber & Eisenberg. “Although most of the pain is being felt by equity investors, debt investors haven’t been spared.
“A lot of people are doing triage to make sure they are supporting their good portfolio companies – and there are plenty of great companies in the market today.” Gray admits he is seeing a significant number of companies go out of business.
Another overarching issue is the malaise in the large-bank syndication market, which has steered direct lenders away from riskier venture debt toward less risky leveraged buyout deals.
“Larger direct lenders who might have financed venture deals are stepping into what was historically a bank capital opportunity for less risky deals,” says Jono Peters, a director at New York-based Union Square Advisors, a technology-focused investment bank.
That has created a vacuum for mid-market venture lenders to fill. Consequently, Peters says his team is the busiest it has ever been, both in venture and other deals.
Noah Shipman – a partner at Vancouver-based Vistara Growth, which invests in growth debt and equity to both sponsored and non-sponsored companies – says the firm has a record number of term sheets outstanding, and did its largest deal ever in April, soon after the drama at SVB unfolded.
Although Thoma Bravo doesn’t compete with those like SVB that were lending to early-stage companies, the software and tech-enabled private equity firm’s credit team has seen “a pretty meaningful pickup in pipeline activity in the last four to six weeks” among the larger, more established firms with which it does business, Oliver Thym, a partner on the credit team, told Private Debt Investor in June.
The situation in the rearview mirror for the overall VC market, however, has been markedly different, with activity levels early in the year under significant pressure.
According to PitchBook-NVCA’s Venture Monitor: “Among traditional investors, 2023’s fundraising has been abysmal,” with just $11.7 billion raised in the VC market in the first quarter. Venture debt activity fell to just $3.5 billion in the period, with healthcare debt $400 million behind the prior year’s pace.
Indeed, Runway, which finances late- and growth-stage companies, didn’t originate any new loans in the first quarter. On its earnings call, the company said the lack of activity reflected “seasonality and the conviction” with which it evaluates investments. Runway said it continues “to see healthy demand from quality companies with clear paths to profitability, seeking to use debt as non-dilutive growth capital”. It added that its credit bar has never been higher, and the team remains “extremely selective” in adding new companies to Runway’s portfolio.
Cushman & Wakefield data cited by affiliate title Real Estate Capital USA found that venture funding for US life sciences companies slipped 28 percent in 2022, to $35.8 billion from $49.2 billion in 2021.
Investors are closely watching VC valuations and could start to push back on fundraising if prices continue to fall. Affiliate title Buyouts Insider, citing a report from PJT Park Hill, reported in late May that secondaries pricing on VC funds fell in the range to 63-68 percent of net asset value in the first quarter.
Three-quarters of limited partners polled in the summer edition of Coller Capital’s Global Private Equity Barometer said they were expecting more down rounds in their venture capital portfolios in the next 12 months compared with the last year, with North American LPs expecting a higher 85 percent of down rounds.
Unsurprisingly, the performance of VC funds has suffered, experiencing negative returns for three consecutive quarters last year for the first time in more than a decade, according to PitchBook.
Nevertheless, some see opportunity for venture lenders created by the regional bank pullback. “There’s a massive hole in participants in the lower end of the debt markets because the traditional banks that competed with SVB don’t have the balance sheets to fill the gap,” says Gray of Neal, Gerber & Eisenberg.
Thus, despite parlous VC fund performance, some venture debt players are rushing to capture greater market share. Soon after the collapse of SVB, Hercules Capital’s Hercules Adviser announced it had formed a new private credit lending programme to back venture and growth-stage companies.
Hercules Capital itself has been clocking some impressive results. It reported record gross new fundings in the first quarter, with CEO Scott Bluestein telling PDI that quality has been “exceptionally strong” on the investment side. Although he notes that the exit of SVB as the largest player in venture lending in the past 40 years was “a significant blow to the market broadly”, he says it was “a massive opportunity” for Hercules. The Hercules platform is currently managing more than $3.9 billion in assets between its public and private funds business.
“We’re going to play offence here without sacrificing our very high underwriting standards; our balance sheet is incredibly strong and we’re looking forward to taking advantage of the market opportunity that’s before us,” Bluestein says.
Still, it would be premature to entirely count out SVB, which was acquired by First Citizens Bank in late March. Indeed, the bank seems to have made a quick recovery, to the surprise of even those who remained.
“It’s business as usual at SVB; they didn’t see a lot of clients leave,” says Charlie Perer, a co-founder and head of originations at SG Credit Partners, a family office-backed lender whose platform includes a division focused on software and technology.
Vistara’s Shipman says SVB isn’t trying to get refinanced out of existing deals, although it has been reducing the size and leverage in its initial offers and tightening its terms.
Perer believes the venture debt market is going to get bigger and more competitive, and he isn’t alone. In early June, global asset manager BlackRock announced plans to acquire Kreos Capital, a London-headquartered firm that provides growth and venture debt funding for the technology and healthcare sectors. In addition, the California Public Employees’ Retirement System, the US’s biggest public pension, is reportedly planning a multi-billion-dollar push into international venture capital.
“With SVB becoming more conservative and the reverberations from SVB in regional banking, there is a void in venture lending,” Shipman says. “The void is only going to get bigger.”