Why investors are taking a plunge on venture debt

Amid the turmoil caused by the pandemic, technology and life science firms are seeing strong growth – and lenders are taking advantage.

We live in risky times. But is it a good time for risky investments? Instinctively, you probably would not think so, but venture debt – sitting at the higher-risk, higher-return end of the private debt lending spectrum – appears to be flourishing.

According to PitchBook figures, the US saw more than $26 billion-worth of venture debt activity last year – the highest annual total since at least 2006. Based on what’s happened so far this year, 2020 could be on course to set another record.

If it seems a little counterintuitive, perhaps the first point to consider is that two sectors popular with venture lenders – technology and life sciences – also happen to be among the most popular for investors at the current time (see our feature on private debt’s hottest sectors here). This should be no surprise: the April to December 2020 period is expected to see a level of growth for tech and life science companies equivalent to what would normally be seen over four to five years.

When companies are growing that fast, the need for financing can be urgent – and that’s where venture debt comes in. “When covid hit, every start-up was asking about venture debt,” Scott Orn, chief operating officer of Kruze Consultancy, told us.

But why venture debt and not equity? In many cases, the two go together with equity and debt providers supporting the same deals. Indeed, investing alongside a large, well-established VC firm can give a venture lender a lot of confidence that they will stand behind a company through tough times – as well as the prospect, on occasions, of turbocharged returns.

But while venture capital has been going reasonably strongly, economic uncertainty is giving investors pause. Moreover, with debt able to avoid equity-related valuation issues and dilutive financing rounds, there are plenty of businesses prepared to view debt as a replacement for equity rather than just a complement.

This confidence is being seen in the business development company market, which has been hit hard by the pandemic but where demand for those focused on the venture market is strong. What’s more, with debt penetration of the technology sector currently very low, there appears to be plenty of room for further growth.

Write to the author at robin.b@peimedia.com.