Venture debt in this new world
I’m continually being asked the same questions of late; are you still open for business? How is the current market impacting your product? Is debt right for me now?
I thought I’d write a short opinion piece giving you my thoughts on venture credit and how it may be a lifeline for your company in the current market, possibly one which you never thought existed.
As investors look inwards at their own portfolio companies to assess the damage from the ongoing storm, they wonder:
How long will the storm last? Will it get worse before it gets better? What damage will be left for years ahead?
The reality is, no one knows how long government restrictions due to COVID-19 will be here for, no one knows when we will return to back to reality or in fact what the new reality will look like. What we do know is that people will be more conservative for some time while sentiment is low.
According to Westpac’s Consumer Sentiment Index, consumer confidence fell 17.7% in April to the lowest level in 47 years. It is now inevitable that the world is entering a recessionary period and for Australia this will be the first time for nearly 30 years.
This will impact the tech community in a variety of ways.
- Firstly, most cyclical businesses will be impacted by a reduction in demand driven by lower consumer and business spend as customers are more cautious.
- Additionally, the predictability of customer behaviour also becomes more difficult. CAC may increase, churn may fluctuate and lifetime value decline. Everyone has their own issues remember. You may be one of those lucky businesses which is seeing a spike in demand, in fact we are seeing it in some of our portfolio companies — but don’t get complacent.
- Market uncertainty leads to risk aversion. In turn, investors are taking longer to make decisions and are increasingly selective in what they back. Capital dries up as existing committed/allocated capital is spent and it is harder for those investors to raise more. No one knows at what level to set valuations, but everyone knows it’s directionally lower than it was before this crisis.
Given all of the above, the consistent message across the global community is to:
- Maximise your runway,
- Cut fat from your business,
- Don’t rely on third party fundraising,
- Take what you can today,
- Draw down on your available credit lines.
I echo this, as being a leaner operation and knowing that you have time to execute your new plan and come out the other side while others fall by the wayside will put you in the best position.
Returning to my opening question. We are very much open for business.
Debt is a source of funding which will help you extend your runway either by adding to your cash pile today, or it can function as a credit line which is available later if you need it, like an ‘insurance policy’ thereby extending your runway. The latter credit line option may be cheaper for you, especially if you don’t ever need it, but make sure whoever is offering it follows through with their commitment. A bird in the hand may be worth two in the bush.
Debt is also attractive to companies as it helps avoid the valuation ‘elephant in the room’. This avoids complicated discussions between investors and founders who see the situation through different lenses. Some investors may not be able to commit to new equity right now either. Depending on your company performance and when you last raised, you may also be looking at a down round which makes the situation even more complex. New investors are likely to price lower than existing investors. Debt alongside an internal round may be a solution which reduces dilution but fills the funding gap today, while delaying the next funding round until skies are clearer.
Don’t forget, investors are currently using up their reserves to sure up their existing portfolio companies and therefore will have less to go around for the future.
Paying for reassurance can be invaluable. Whilst of course there is a cost for debt, can you put a price on life?
