The year 2016 may go down as the year of debt for startups, a new report suggests.
Venture capitalist plunged to its lowest levels in two years in the last quarter to $2.4 billion for fintech startups. But founders — especially for fintechs — still needed access to capital. Bloomberg reports:
No one publishes national data on venture debt, but a half dozen lenders provided numbers showing activity spiked in 2016. Silicon Valley Bank’s loan volume to venture-backed startups surged 19 percent during the past year to $1.1 billion for the quarter ending Sept 30. Wellington Financial made more than 10 new loans to venture-backed startups in 2016, double last year’s total. At Hercules Capital, annual volume is up and the average deal size increased 16 percent year-over-year to $15.6 million. TriplePoint’s volume is up more than 25 percent. Western Technology Investment CEO Maurice Werdegar called volume “robust” and described the lending environment as “hyper-competitive.”
Convertible debt has long been part of the equation for venture capitalist but is rarely separated in roundup numbers. Venture debt is specifically excluded from quarterly numbers in the CB Insights/KPMG statistics.
Back in October 2015, VC Mike Fernandez of B Capital noted that fintechs were leaning more heavily on debt than other sectors — largely because of the emergence of marketplace lenders like Lending Club or Kreditech or SoFi. Fernandez explains:
These lines of credit are typically warehouse lines that allow the startup to underwrite a loan on their own balance sheet before securitizing it or directly selling it to another bank, hedge fund, or crowdfunding group who will hold and trade the loan for the remainder of its life. In today’s low interest rate environment, debt investors are hunting for startups that can use data analytics and new credit models to find incrementally better yield and loan performance. In addition to the warehouse lines, some of these investors are letting startups underwrite loans directly on to their own, substantially larger, debt facilities. In this sense, today’s alternative lending startups are really 2-sided marketplaces between borrowers and the ultimate debt investors.
Marketplace investors are keeping a close eye on just how open the credit spigot is for these startups ever since the troubles at Lending Club. OnDeck recently secured $200 million in financing from Credit Suisse. As the sector becomes more crowded, lenders will be keeping a watchful eye on defaults on client loans, especially as interest rates appear set to rise.
Chirag Shah, founder and CEO of Nucleus Commercial Finance, told Business Insider that he expects 2017 to be a tough year for peer-to-peer lenders. Top names will be able to commandeer the best credits, leaving smaller startups to do battle for lower tier credits, a story that is unlikely to end well.
Some startups like debt because they avoid equity dilution. But covenants can be stringent and lenders unforgiving. That’s a story that GigaOm could tell all too well.