Cracking the Code of Venture Debt in a Changing Landscape

The Canadian startup ecosystem has witnessed a remarkable explosion in recent years, and venture debt has become a crucial tool for companies to leverage. New financing options such as MRR lines, acquisition lines, and senior term loans have emerged to support negative cash flow businesses.

Until recently, these debt instruments were cheap, non-restrictive and often undrawn. They benefited both founders, who got flexibility, and lenders, who built strong relationships with early stage, high growth technology companies. Historically, a single debt process could garner six to eight term sheets, and the round would close within weeks. 

Fast forward to today. Driven by various factors, such as inflation and rising interest rates, the landscape of venture debt has undergone a radical transformation. The recent SVB demise has displaced tech companies, forcing them to reassess their debt needs and seek out new lenders to access capital. At the same time, banks are scrambling to understand their risk appetite for EBITDA negative technology businesses. 

We’re Here to Help – Guidance to Making Informed Venture Debt Decisions

It is essential to understand debt structures and how they are changing in this environment. Inovia actively supports our portfolio companies to equip founders and management teams with the knowledge and resources to make informed choices when considering venture debt.

We continue to solidify our relationships across key Canadian, US and international lending partners. In addition, our in-house Venture Debt champions, Meryl Almeida and Mia Morisset, are intentional about staying current on industry trends and participating in peer discussions. This past May, Mia sat on the Venture Debt panel at the Scotiabank Venture Capital and Innovation Summit with David Rozin, Vice-President, Head of Technology at Roynat, Brahm Klar, Partner at Round13 Capital and David Hogarth, Partner at Rhino Ventures.

Here are some key observations to keep in mind as you navigate the next few months: 

1. Make strategic use of debt to optimize your outcomes

Debt is not a cheap option that you can casually take on. Lenders want to see a path to profitability, and as a result unpredictable revenue models or highly leveraged balance sheets impede raising new capital. Ensure there is a real need and rationale behind leaning on this pillar to scale your business.

Scenarios where debt provides meaningful benefits:

  • When used to fuel additional growth once profitable unit economics have been established.
  • Financing acquisitions to supplement organic growth; when targets have favorable unit economics, or the acquirer has a distinctive path to profitability post acquisition

Recognizing situations unsuitable for venture debt is equally important. In scenarios where your company may still be navigating product market fit, or has minimal recurring revenue, debt covenants tend to be more stringent and terms may be more restrictive. Consider alternatives such as reducing burn or reaching out to existing investors for a bridge round.

2. Choose a banking partner that understands your business

Build relationships with various banking institutions, allowing you to choose the best partner based on mutual trust and not just the terms of the deal or the amount of debt extended. The strength of your banking relationship will help you weather more challenging times, since both parties understand the business, its needs and constraints.

3. Ensure alignment between your Management Team, Board and Lenders

The decision to borrow and the performance metrics assigned to the debt can impact your company’s future trajectory. 

Involve your board and advisors in the decision-making process, and stress test the terms you sign up for based on worst case scenarios. If you notice covenants presented are based on revenue growth or profitability metrics, it’s wise to double check with your board and management to understand if you want to align against those metrics and what that could mean for the broader business in the long run (eg. forcing revenue growth in a world of reduced burn). Non-financial requirements and a higher frequency of reporting can also add more operational pressure to your team. Get the help of your board and advisors to conduct reference checks on the lender, just as you would for an equity partner.

The next few months will set precedent for what are considered acceptable terms and companies should ensure they are able to meet the terms of the loan in alignment with their board and the lenders. 

Driving the Venture Debt Conversation 

Cracking the code of venture debt is a process. It requires ongoing evaluation of business needs, market conditions, and the availability of suitable financing options. With careful consideration and strategic planning, venture debt can be a valuable tool to fuel your company’s growth.

Inovia will continue contributing to the dialogue and sharing industry best practices. We would love to hear your thoughts. Please reach out to Mia or Meryl to continue the conversation.