Sub-prime lending thrives amid shrinking venture capital funding

Venture lending, which has long lagged in the startup funding market, has seen growing interest in recent quarters as fast-growing, cash-hungry companies tap into the debt market for capital, in the hope of gaining more time before embarking on a new round.

Startups in need of cash see debt financing as a way to avoid more dilutive equity investments at a time when falling public market valuations, a frozen IPO market and investor withdrawal from Later-stage and pre-IPO startups have created a growing funding gap.

Blackstone’s recent push into the subprime debt market, reported last week by The Information, is the latest example of major asset managers taking action to capture this pent-up demand.

Other non-bank lenders have also shown increased interest in the market. Private equity and venture capital investor Insight Partners is reportedly raising its second structured equity-focused fund, while credit hedge fund King Street is stepping up its search for opportunities by providing high-yield loans to technology companies in growth phase.

According to the report, Blackstone has earmarked at least $2 billion for tech debt deals, including venture debt and hybrid financing for pre- and post-IPO startups, marking its first major foray into the technology market. risk loans.

Blackstone could not be reached for comment.

“There is a lot of pressure building up in the late stage, where many companies need to raise some form of funding to be able to continue operating until they are able to access the public market, and that capital isn’t available in stock markets,” said Kyle Stanford, senior analyst at PitchBook. “It might be the best option for these companies to raise a large amount of debt and continue to grow at a more sustainable pace without a significant amount of dilution.”

So far this year, only 27 companies have gone public in the United States, raising a total of $4.2 billion as of Aug. 16, according to data from PitchBook. That’s a huge drop from last year, when 185 companies went public, raising a total of $538.5 billion.

Meanwhile, there are 50 unicorns in the United States that haven’t raised a fundraiser in the past two years. These companies will likely need to raise new funds soon in order to expand their financial trails and see themselves through today’s more challenging fundraising environment. Venture capital debt is an increasingly attractive solution to their growing capital needs.

As valuations in private markets fell in the first two quarters of 2022, some high-flying startups, including Stripe and Instacart, were driven to sell stocks at lower valuations. Other founders and sponsors have resorted to debt financing and hybrid alternatives, including structured shares and convertible bonds, to avoid declines.

“There are a lot of energy-intensive businesses that were built for growth, not short-term profitability,” said Paul Goldschmid, partner and co-portfolio manager at King Street. “These companies have seen this sudden increase in their cost of equity, and they don’t know what to do about it. A lot of them will look to the credit markets. There’s a very big capital opportunity there. “

Some of these debt financings could seek returns in the mid-teens, Goldschmid said.

Welcome, newcomers

A few established players have said they expect subprime debt and other funding offerings from major asset managers such as Blackstone to complement the current world of subprime lending.

Indeed, Blackstone’s move could improve repayment and exit opportunities for existing subprime debt lenders, which typically exit through public listings, M&A transactions and refinancings by large lenders. banks, said Daniel Devorsetz, CIO at Horizon Technology Finance, a venture debt firm focused on technology and life sciences companies.

“Blackstone recognizes this market opportunity and is going after the upper end of the venture capital world, which needs more capital providers,” he said. “There are not enough providers of capital in this part of the market.”

Devorsetz added that investors active in both growth-stage startups and mature mid-market companies pulled out.

“There has been a pullback among cross investors filling this gap, and Blackstone can help fill this market need.”

Although on the rise, the US venture capital debt market remains small. In 2021, venture capital-backed U.S. companies received $33.1 billion worth of debt funding, less than a tenth of venture capital deals, which reached a record high of $341.5 billion last year, according to PitchBook data.

Other private equity firms have already dabbled in financing pre-profitable growth companies. Ares Management entered the venture debt space in 2012, but the company did not pursue it as a major line of business and eventually sold its portfolio to Hercules Capital in 2017.

Venture lending typically requires investors to take out a loan based on the enterprise value of the borrower, a different approach to underwriting debt in buyout financing deals that are structured against the cash flows of the borrower. a company, said David Spreng, CEO and CIO of Runway Growth Capital.

Featured image by Watchara Ritjan/Shutterstock

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