Last month, the abrupt failure of the accounting startup Bench was triggered when its lenders called in the startup’s loan. In late 2023, Convoy, a digital freight company, suffered financial difficulties, prompting the venture lending firm Hercules Capital to take control to recover its investments.
Divvy Homes, which was acquired for approximately $1 billion by Brookfield Properties last week, has left some shareholders without any return, as reported by StartupSuperb. While the exact involvement of Divvy’s lenders in the transaction remains vague, the company secured $735 million from Barclays, Goldman Sachs, Cross River Bank, and others in 2021.
Following the influx of funding for numerous weak startups during 2020 and 2021, many of these enterprises have already collapsed. However, indicators reveal that the worst may not be over, with a prediction of more failures anticipated in 2025. Venture debt will be a significant factor, having reached an all-time high of $41 billion across 2,339 deals in 2021, according to Silicon Valley Bank.
As expressed by David Spreng, the founder and CEO of venture debt provider Runway Growth Capital, the situation for numerous companies is reaching a critical juncture.
To mitigate potential losses, lenders are increasingly advising startups to consider selling themselves, according to Spreng.
It is estimated by John Markell, a managing partner at venture debt advisory firm Armentum Partners, that nearly every lender now has struggling companies within their portfolios.
While debt can assist rapidly growing startups in meeting their cash flow needs without needing to relinquish equity to venture capitalists, it simultaneously amplifies the risk of adverse outcomes. An imbalance of too much debt compared to a startup’s income or cash reserves may result in a forced sale, where a company is sold for significantly less than its prior valuation. Alternatively, lenders might proceed with foreclosure to reclaim assets pledged as collateral to recuperate some of their investments.
Startups that manage to convince new or existing venture capitalists to inject additional funds by acquiring more equity can avoid lender actions if they fall behind on payments or other obligations. Some venture debt agreements contain liquidity and working capital ratio stipulations, whereby low cash reserves could prompt lender intervention.
However, investors are hesitant to continue financing startups that exhibit slow growth rates insufficient to validate the inflated valuations they secured during 2020 and 2021.
Markell noted that numerous troubled companies are currently in operation. A significant number of unicorns are unlikely to sustain their businesses for much longer.
Spreng foresees that many startups will ultimately have to accept low buyout offers or cease operations altogether this year. Yet, for the time being, the majority of lenders remain optimistic that these startups might find potential buyers, even if at reduced prices.
In scenarios where lenders demand a sale, equity investors typically receive little from the transaction, often failing to recover their investments, as noted by Markell. Venture capitalists are aware that losses on startup investments are an inherent risk.
When a sale occurs, Spreng mentioned that many of these deals go undisclosed due to the disappointing outcomes for venture investors. No one is eager to celebrate a defeat resulting in financial loss.
Nevertheless, since debt holders have repayment priority, venture lenders are less likely to face total capital loss.
Despite the risks linked to venture debt, its attractiveness remains undiminished. In 2024, new venture debt issuance surged to a 10-year peak of $53.3 billion, according to PitchBook data. A notable portion of these funds was allocated to AI companies, with significant instances such as CoreWeave obtaining $7.5 billion in debt financing and OpenAI securing a $4 billion credit line.