Bottom line
During this rebound phase, early-stage start-ups should plan to keep more cash on hand to weather economic uncertainty if funding becomes more difficult to obtain down the road. They should also plan for the risk that debt may be challenging or impossible to obtain, and they may need to raise further equity rounds at lower prices. These developments in the market are likely to encourage early-stage tech companies to build more stable growth over time.
Regulators had seen early signs that SVB was in trouble as early as 2021, however, bank managers failed to address the problems.12 In the wake of the bank failure, questions have been raised about the role of regulatory bodies in preventing bank failures. In 2018, regulations in the Dodd-Frank Act which went into effect during the 2008 recession were amended to exempt banks with assets between US$100–250 billion from keeping sufficient liquid cash for thirty days of withdrawals on hand at all times.13 Some have argued that this change, combined with SVB management’s failure to address concerns, appears to be a significant contributor to the bank’s failure.14 As a result, many observers anticipate more regulation,15 which could contribute to the cooling of venture debt markets in the short term.
For financial institutions, the collapse and rebound of the venture debt market presents a compelling opportunity to gain market share. Institutions moving into the venture lending space should proceed cautiously to manage heightened risk. For example, lenders may need to ask for more warrants, in order to buy stock at a predetermined price, possibly at lower strike prices, in order to help reduce their risk factors.
Nonetheless, one possibility that venture debt could unlock for the tech startup ecosystem is serving as an additional pathway to raise funding. And it could work well both for the lender (less risky) and the borrower (access to funds of smaller ticket size). Beyond traditional VCs, venture debt could serve as an alternate asset class for tech startups to keep the innovation engine on. For instance, venture debt lenders can help startups by offering lighter funding in the range of US$5–8 million to support pilots and prototypes (for example, generative AI solutions) via strategic joint ventures, academic collaborations, joining hands with adjacent tech players as part of an industry consortia, or participating in ideation labs and other accelerator programs.
Moreover, startups are sprouting in new areas such as sustainable tech (for example, ESG software and analytics, AgTech) and generative AI and private large language models. These new areas are expected to require a continuous flow of funds to help those startups launch innovative solutions to help generate value for their customers. Venture debt can serve as another plausible alternative investment avenue for the hundreds of new/emerging startups, beyond the established investment avenues such as VCs and PEs.
All said, tech start-ups may still have to think carefully about their funding strategies in the coming year as venture debt funding recovers. Still, as the market recovers, tech start-ups will likely be well-positioned to build toward sustainable growth in the future.
