Venture debt has become an increasingly popular option for startups looking to finance their growth without giving up equity. However, as interest rates rise, the landscape for venture debt is about to change. In this blog post, we will explore some of the trends in the venture debt market in a high interest rate environment and how they are impacting both startups (borrowers) and capital providers (lenders).
First and foremost, demand for venture debt is likely to continue to increase in a high interest rate environment. As interest rates rise and equity valuations cool down the cost of equity financing becomes more expensive (higher dilution), making venture debt a more attractive option for startups. Venture debt does not dilute the equity of the company which makes it a more appealing option for founders who want to retain control of their company.
However, the rising interest rates also mean that the cost of venture debt may increase is some cases. This is because venture debt lenders typically base their interest rates on a benchmark rate, such as the prime rate LIBOR. As these rates increase, the cost of venture debt will also go up. This could make it more difficult for startups to afford venture debt, especially if they are already struggling to meet their financial obligations.
In addition to the impact on debt costs, the rise in interest rates could also affect the terms of venture debt. As lenders become more cautious, they may be less willing to lend to high-risk startups. This could result in stricter underwriting criteria, such as higher minimum revenue or cash flow requirements, as well as shorter loan terms and larger payback obligations.
During 2021 large capital commitments at for the next 2-3 years at attractive cost of capital. However, other capital providers may be impacted by the rise in interest rates. As interest rates rise, the cost of future lending becomes more expensive for those lenders who have not secured capital before Summer 2022. In the long run this could lead to a decrease in the amount of capital available for venture debt. This could make it more difficult for startups to secure the financing they need to grow their businesses at good terms.
In conclusion, the rise in interest rates might have a significant impact on the venture debt market in the future. As interest rates increase, the cost of venture debt is also going up, which could make it more difficult for startups to afford. Additionally, the stricter underwriting criteria and limited availability of capital from lenders could make it more challenging for startups to secure the financing they need to grow their businesses.
As long as the leading venture debt lenders are using capital which they raised at lower cost – it seems that startups should seize the opportunity and raise venture debt now. Later into 2023 venture debt availability and terms can be tighter.
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