Shifting sands in the venture lending world
For every door that closes, a window opens; or so the cliché goes anyway. In the venture debt sector over the past 24 months, it seems that for every capital window that opens, a door has closed. Sometimes even at the same shop. For companies that might be considering raising venture debt in 2014 and beyond, the developments are meaningful for many entrepreneurs and their VC backers.
According to Preqin’s robust database, there are perhaps nine firms in our space that have raised a new fund in the 2005-09 period. The names will be known to many VCs and entrepreneurs: Gold Hill, Lighthouse, Partners For Growth, Pinnacle and WTI, for example. If you launched a fund during that window, now’s about the time for you to be back in the market, as we were in 2012 with our new $600 million investment program via Wellington Financial Fund IV.
In the wake of that fundraising cohort, which happened to lead in to the global financial crisis, other firms announced plans to start lending to the innovation ecosystem around the time that things were getting more rosy. Those names included, 5th Street, NXT Capital and Silver Lake Waterman to pick three examples. Some were lenders by trade and thought they’d get some margin pickup in the innovation sector, while others were already big players in the tech equity space and figured they might as well move up the balance sheet in an already attractive adjacent vertical.
Four years ago, we’d have told our Limited Partners that there were 8-12 active firms in the sector across Canada and the USA; the reason it wasn’t a fixed number was simply because some firms had limited discretionary capital and weren’t always able to issue term sheets as a result.
In a few cases, firms rely on their own bank warehouse lines and should they ever not be in compliance with their lender’s borrowing base, they are “out of the market” until that’s fixed. Put another way, some teams didn’t always have dedicated capital, or may have had to rely upon hedge funds or commercial banks to approve each term sheet for funding once they’d landed the deal. Not everyone, of course, but many experienced VCs have come to learn that not every venture debt firm is the same for this among other reasons.
Pre-2008, VCs didn’t seem to care if a venture debt firm was levered; today, that’s one of the first five questions you are asked when you are out marketing.
With that muddy backdrop, the number of firms in our space began to grow over the past few years. Despite what MMV claimed in 2011 (see prior post “One man’s ‘competition’ is another’s opportunity“), there was lots of business to go around. Consumers of debt responded positively to the increased capital availability. Sadly, the space has also now pulled a bit of a U-turn.
Despite putting out a decent amount of capital over the past 24 months across several sub-sectors, Chicago’s NXT Capital is just the most recent example of a firm that has exited the venture lending. It wasn’t that long ago that the team, originally with Velocity Capital, had begun a fresh marketing push across the USA and Canada. Backed by equity from the Ontario Teachers Pension Plan, among others, they were off to the races. Earlier this week, Fortune Magazine spilled the beans that things were over. As recently as 16 months ago, NXT’s parent company was talking about carving out $500 million of “stable committed capital” from its $3 billion funding vehicle for tech and life science deals.
At some point a few weeks ago, it sounds as though the dedicated team was informed that the overall asset allocation strategy had changed, and that venture no longer had a material impact on the parent company. All but two of the senior venture folks left soon thereafter, which is always sad to see and certainly wasn’t something to blog about until it was public. Such a shame for the team, many of whom came from Velocity, and the portfolio companies who now find themselves in a maintenance relationship.
The storyline isn’t unique, unfortunately, as at least two other venture debt firms have gone quiet; in these cases, it sounds as though they haven’t been able to attract meaningful institutional interest for their follow-on funds. Weak returns? Losses? Changes in personnel at the LP end?
In many ways, that’s the nature of the beast, as LPs are forever going through the exercise of trying to focus their capital on their highest performing, and least volatile, fund strategies on a risk-adjusted basis.
All of this change, though, is having an impact on the dozens of high growth VC-backed borrowers who suddenly find themselves with a dance partner who is, in some cases anyway, no longer able to dance.
All of which is one more reminder why it is so important for entrepreneurs to understand the funding dynamics, sectoral focus, and longevity of the firm they are looking to partner with. Lending in the innovation space requires a particular skillset, and a dedicated mandate. For the same reason you can’t be a “sometime” VC fund, CFOs are quickly realizing that innovation lending also requires a specific skillset, experience, and transparency around the source of capital and the future runway of that capital pool.
As an innovation-focused team with an unlevered, pension-backed fund that’s committed beyond 2020, we are looking forward to continuing to serve the needs of the sector for many years to come.