Insights / 08 July 2021
Crestbridge and British Venture Capital Association (‘BVCA’) roundtable discussion on venture debt growth and innovative applications of the model
Over the course of the BVCA roundtable on venture debt, chaired and sponsored by Crestbridge, Alex Di Santo (Head of Private Equity for Crestbridge) and Mark Collins (Director, Fund Services for Crestbridge) were joined by prominent guests from across the venture capital and debt industry, including some of the best known and biggest names in the space in the UK.
Read on to find out why and how more managers are using venture debt to fuel the growth of the next generation of unicorns – from traditional debt products to marketing data-based lending.
Venture debt makes up approximately 20% of the venture capital market in the USA according to Pitchbook data, and the UK and Europe is expected to follow suit, participants at the Crestbridge and BVCA event on venture debt heard.
But what are the factors driving this activity? Alex Di Santo, chairing the event, gave a rundown of the key points.
“It’s a non-dilutive form of funding, which clearly leads to more upside for the founder. US research suggests that founders going down this route can retain around an extra ten percent of ownership when combining venture debt with equity, versus solely using equity financing.”
“It also gives more control to founders,” Alex said. “On the equity side, investors require board seats, input on key hires and so forth. Financing through debt avoids this relinquishing of control, which may suit founders more.”
Alex continued that “it’s also time consuming to raise equity, whereas using debt funding for specific activities is much quicker. Pitchbook data shows returns from venture debt are very, very attractive for managers and investors alike, so there’s a good incentive to offer the product in the first place.”
Several attendees confirmed that they were interested in exploring venture debt as a way of diversifying their portfolio. “Venture debt is a very exciting area for Crestbridge given the leading Fund Managers we support in the space. We are now seeing much more interest in Europe and expect exposure to the asset class to increase in line with the more mature US market”.
Though venture debt has been described in the past as private debt’s best kept secret, because it’s such an under-utilised asset class, it actually started taking shape as its own model in the mid-to-late ‘90s in the USA. “A few people had this weird idea that lending money to early stage, loss making businesses might be a sensible thing to do,” said one participant.
“Those who started that early could ride the developmental curve of the asset class through to the credit crunch, which was transformational by its nature. First, many financiers were now jobless and had a decision to make about their future. Second, founders quickly saw that the usual means of financing their business were in short supply or ceased to exist. By about 2012, institutional investors started insisting on looking at venture debt products.”
The audience heard that classically, venture debt is defined as a bridge between fundraising series – “although it’s rare to hear venture debt managers defining it like this,” said one participant. Consequently, the decision to lend isn’t entirely based on the borrowing company’s numbers, as much as the syndicate of equity investors already backing the company. The lending is done with the manager knowing that there is a high certainty the borrower will get to the next round of funding, which acts as a safety net for the venture debt partner.
“We’re as much lending against the sponsor base of the company as the company itself. We see ourselves as a partner with the equity investors, not least because the interest on the loan is being paid with their money” said a venture debt manager from the audience.
He continued, “because the loan isn’t made entirely in the traditional way, in order to be successful within this asset class, it’s also important for venture debt managers to have a bit of an equity mindset. The real secret is that when things go wrong, venture debt managers will need to work closely with the equity syndicate and the portfolio company to see the crisis through.”
The discussion opened up to other, non-traditional methods of venture debt financing, notably, using non-traditional indicators such as the strength of a company’s marketing data, rather than runway, to make a lending decision.
“We lend against marketing data, not EBITDAs” said Rajeev Saxena, MD of Juice Ventures. “Once a company has built a product and identified who the target audience is, the success of that business becomes about acquiring customers. As a venture firm, we take equity in the usual way with the usual investment parameters we are all familiar with as an industry, but when it comes to debt, our portfolio companies are only allowed to use it for marketing purposes – that is, customer acquisition.”
Gone are the days when CEOs knew how to spend all of their marketing budget but didn’t know which half was working. “These days, you can track marketing success digitally. We can actually lend against a company’s marketing data, supercharging their market cap as well as being less dilutive.”
“We audit the data and once we’ve established the strength of it, we offer a revolving credit facility between 90 – 120 days depending on the nature of the business. To retain control of spending, our loan goes through a pre-paid credit card style system, which can only be spent in the marketing channels we agree on, for example through Google’s advertising platform. Assets are only loaded back on the cards once we have received our interest – effectively preventing misuse of funds.”
“There clearly has to be certain cashflow provisions in the business as well, but we lend primarily on the strength of the marketing data. We calculate the lifetime value (LTV) and cost per acquisition (CPA) of our prospective borrowers to determine whether to make a loan or not.” The lifetime value of a customer is a measure through which marketers ascertain the total spending a client will make with the company throughout the time they remain a customer. The cost per acquisition is the cost of acquiring new customers in the first place. These calculations help show whether a company can super-charge their marketing in order to attract more customers more quickly, ultimately generating revenues that would be used to repay the loan. “We don’t want to eat into a company’s operating capital, this is about using a loan to generate new sales,” he added.
A platform capable of monitoring the marketing data of the firm’s existing portfolio constituents automatically and in real time is nearing completion. “Once this has been completed, we can scale much, much more and we’ll be ready to help other venture capitalists use our systems too.”
Finally, the discussion turned to the effects of Covid-19 on the sector. The vast majority of participants found that venture debt performed very well over the Covid pandemic. They conceded this was unsurprising, given venture debt loan books are likely to comprise companies that would be expected to do well given the shift to online shopping and other trends that were accelerated over the course of the pandemic.
The conversation ended with the hosts from Crestbridge thanking the audience for joining and for a lively discussion around venture debt, its definition and innovative application of a lending framework.
04 October 2021 / Insights series