Capital Drought or Passing Showers?
Navigating the stormy seas of the growth ecosystem, the first half of 2023 sees us caught in even stronger gales than last year. Yet, fleeting glimpses of calm prompt a question: Are we seeing a break in the storm, or merely resting in the hurricane's deceptive eye?
The heart of the storm: Capital Drought
Feast your eyes on the storm chart below, courtesy of our comrades at Pitchbook, depicting capital deployed in Europe this year. If this trend continues, we're headed for a chilly annualized drop of over 50%. Yet, in the midst of this cold front, there's a beacon of warmth - we've simply navigated back to the more comforting shores of 2020.
Still, in such climate, attempting to raise funds has been about as comfortable as selling air conditioning units in Antarctica. But remember, it's winter everywhere, not just in your backyard.
The Fog of Valuations
Valuations is where things get foggy. Venture capitalists have been painting valuations with an abstract expressionist’s flair. Yet, fear not, for we have an umbrella to shield you from the rain of confusion.
Public data from last year from caplight, is like the trusty weather forecast based on actual secondary market conditions. It showed secondary market valuations tumbling 41% from the last funding round.
This year, the storm has raged on, and data for H1 2023 has yet to be released. Lucky for us at Nighthawk and Rocking Horse, our lending to about 20 startups a month offers a unique barometer on the UK market:
For numerous founders, this changing climate has implied a dreaded down-round, risking turning the financial outlook from a mere drizzle to a full-blown investment drought.
Safe Harbour in Venture Debt?
In light of the looming shadows of down-rounds and shrinking valuations, many entrepreneurs are seeking refuge in the harbour of venture debt. So, how is the weather in our cherished venture debt corner? Put simply, demand has boomed like a thunderstorm.
However, we're facing challenges that make navigating this tempest a tricky endeavour. We've been contending with desert-like VC funding, an HMRC that's become as cooperative as a snow blizzard, and a Bank of England seemingly intent on economic frostbite with relentless rate hikes.
The biggest cloud on the horizon? A dire shortage of debt capital for startups. Consequently, we've been brewing a solution to this drought (watch this space!). Our deep-dive research has uncovered some intriguing patterns:
1. The first one comes from the ever inspiring meteorologists at Andreessen Horowitz, illustrating that, unsurprisingly, the US venture debt market remains resolutely sunny:
2. And here's how the venture debt climate in the UK looks, courtesy of yours truly. As you can see, once again unsurprisingly, the picture it paints is that of a light damp drizzle:
Sure, the UK is smaller than the US, but these charts don’t reveal the reservoir of funds the American venture debt market possesses. In terms of venture debt availability, the UK and Europe aren’t merely facing a drought – we’re more like cacti in the Sahara, yearning for a cloud to grace our skies:
Sources: Pitchbook, Statista, E&Y, CrunchBase
Silver lining: Venture Debt is growing fast
While venture debt might not be as abundant as rain in a monsoon for every start-up, it's growing like cumulus clouds on a sunny day. This burgeoning asset class strikes a balance, much like the perfect climate, between costs, maturity, and dilution. For investors, it provides a safer passage to the most promising start-ups in the market.
Much like a snowflake, venture debt is unique to each provider, with countless ways to structure it. So, what exactly do we mean by venture debt? Let's peek into a typical termsheet:
Now, these are only forecasted terms. Here's a glimpse at the different currents we regularly encounter:
Interest Rates vs. Warrants
It's a tricky balancing act between the interest rate, the amount of warrants, and their strike price. Let me share a little secret with you: in the end, the price is almost always the same - it is a question of do you buy now, pay later, or pay now, gain later.
Maturity
As a rule of thumb, the longer the maturity, the more expensive the debt. Most venture debt also tend to be amortising - the provider will not want to solely rely on a successful equity funding round.
Is venture debt for you?
Is your business eligible for a venture debt loan? You'll need:
- Revenues of at least £100k/month
- At least 6m track record / contracted revenues for the next 12m
In evaluating R&D loans, we may consider factors such as operating margin, sales growth, cash runway, debt ratios, weather patterns, and even the company's approach to ESG and transition to Net Zero.
Navigating the Frost
So, if your business is shivering in the cold and needs a warming shot of liquidity, do get in touch. Share this weather update if you know someone weathering the storm or if you simply got a chuckle out of our meteorological musings.