Q3 data reminds us that venture debt is not a Hail Mary

Venture debt was never meant to be used to bail a company out of financial trouble.

And yet, when venture capitalists started to pull back from equity investing earlier this year because frothy market conditions made them realize that valuations were too high, it became a topic of discussion again. Across the industry, from founders to investors to reporters, the rhetoric among many was that we’d see a drastic rise in venture debt this year.

But why would lenders want to loan cash to businesses that are being abandoned by their investors due to questionable financials — especially in a turbulent market? Well, they don’t. And despite people thinking they would, Q3 data from PitchBook shows that venture debt will likely see fewer deals and less loan volume this year than during last year’s robust equity market.

At the end of the third quarter, $22.8 billion had flowed through 1,925 transactions in the U.S. in 2022. That isn’t likely to rise to the $32.7 billion total or 3,691 deal count from last year. Venture debt isn’t like other areas, including equity or fundraising, in the sense that the numbers are just down compared to last year’s record-breaking figures. Venture debt will likely end 2022 at its lowest total since 2018.

Venture lender David Spreng, the founder and CEO at Runway Growth Capital, isn’t surprised there is a disconnect between the numbers and the public discourse. He said he gets calls from VCs all the time that show they too are a little confused about how venture debt financing from lenders like Runway works.

“What you just described is the bane of my existence,” Spreng said. “‘They’ll just raise debt if they can’t raise equity,’ [investors say], but that is actually the exact opposite. We are not rescue finance. We are not if you can’t raise equity.”

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He said that while equity financing tends to be more expensive than debt, lenders like his firm — which invests in late-stage, more established startups — are still generally looking for the same things as their equity counterparts: scale, revenue and a solid business plan.

“Lenders do not lend to companies that really can’t raise equity; that’s a common misconception,” he said. “You should sell your company or go out of business if you can’t raise equity. But if you can raise equity, you should consider raising debt.”

This actually makes total sense. When equity is down, venture debt is also going to be down because both backers are looking for largely the same positive markers in a company. Plus, a lot of companies raise rounds that include both equity and debt, so if fewer financing rounds are happening in general, inherently fewer debt transactions are, too.

But Spreng said while it’s true that the companies getting abandoned by their backers aren’t going to bring up this year’s venture debt numbers, he said that the PitchBook data doesn’t give the full story. He said for lenders like him, and others he considers similar, like Western Technology Investment and Hercules Capital, they’ve been busier than ever.

The fact that Spreng and the other publicly traded debt business development corporations are having their best years, despite all of this, also makes sense because of extension financing. While some companies are scrambling to raise financing due to cash burns and lofty valuations, many other solid startups are looking to raise some financing to pad their balance sheets in the event that market conditions get even worse. This has been the case for equity backing this year as well.

Plus, not every company is doing poorly this year, he said. A lot of the companies Runway works with are still seeing growth and may be taking on debt financing to expand sales and marketing efforts.

But for the companies who thought they could turn to debt because they were in trouble, unfortunately, that won’t be the case. Equity investors have said all year that good companies would still have no trouble raising in this environment, and that’s proved true for debt as well.