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The Post-SVB Software Debt Market
Understanding potential capital source options is important in this market
Some folks have asked me about the software debt market and with everything that has happened with SVB (and potential implications with the startup debt market) I thought it deserved a post. But I am no expert on this topic so I asked someone that is an expert to help me. While there are lots of opinions out there on debt for high-growth and early-stage software companies, it’s important for founders to understand their options, the pros/cons, and what business profiles might make sense for each.
Rob Belcher at SaaS Capital has been living and breathing the software debt market for a long time so I asked him to guest write on this topic (Thanks, Rob!).
Let’s get to Rob’s write-up…
Author: Rob Belcher
Both the technology and financial industries were rocked a little over a week ago when the FDIC stepped in and took over Silicon Valley Bank. It may be a “niche” bank in the global scale of things, but SVB was the 800 pound gorilla of banking startups, technology companies, and their equity capital providers (VCs and PEs). SVB’s market share was an astonishing 44% of all venture-backed technology and life science companies. Their sudden, unexpected, and dramatic collapse has left an enormous hole in the technology banking and lending space.
The Software Debt Market Today
There are still the same players as before:
Non-bank venture lenders
Alternative lenders (including MRR lenders like SaaS Capital, and revenue-based lenders like Lighter Capital)
These capital sources provide different loan structures, with varying costs, covenants and criteria. We think of the market like in the grid below.
One big recent change to this chart is that SVB, the single largest participant on the bank quadrant, is gone, possibly leaving a giant smoking crater of opportunity.
(I say ‘possibly’ because as it stands now (week of March 20), Silicon Valley Bridge Bank (side note: this is an incredibly poor naming choice seeing as their closest competitor is, in fact, called Bridge Bank, with headquarters in .... Silicon Valley) has communicated that it is operating business as usual and all systems are a go. It is also in the process of trying to find a buyer. Most of the press I’ve read states that buyers are interested in the loan book but not the ongoing lending operations. But the company may not find a buyer and may continue to operate with the FDIC as the sole shareholder! There is plenty of uncertainty still at this point.)
Also, a new, more aggressive variant of Revenue-Based Financing, which we call “Subscription Cash Advance,” belongs in the Revenue-based / royalty-based lending quadrant, and I’ll describe it in more detail below.
So what are the software debt options?
First, a word on the relationship of SVB’s collapse to early-stage bank lending. The news has focused on the SVB’s loan book in a somewhat misleading manner. Although they had over $200 billion in assets (mostly bonds, not loans), SVB’s actual loans were $75 billion, and only 21% of that went to tech companies. More than half of that was lending to late-stage companies (over $50 million in revenue). That boils down to less than $7B in actual early-stage tech lending from SVB. Even a total writedown of their actual early-stage loan book wouldn’t have sunk SVB – it was instead a much smaller percentage loss on their massively larger bond portfolio that actually killed the bank.
Tech banks, SVB included, actually play at the smaller size end of debt financing, because of their risk-aversion. Banks generally offer two products at the early stage:
Relatively small working capital lines of credit (LOCs)
Larger, “sponsored” term loans for venture-backed startups.
Non-venture-backed early stage entrepreneurs may be able to get a working capital LOC with a personal guarantee, and capital availability will be limited to 70-80% of the accounts receivable balance. To access a true venture loan, however, the company needs to have done a meaningful, recent equity round with VCs who have some previous working relationship with that bank – this is called having an “equity sponsor,” and is a core part of the underwriting model of all the tech banks below.
Bridge Bank remains one of the few remaining tech-focused banks, although since 2015 it has operated as an independent division of generalist bank Western Alliance. (Take care – don’t confuse “Bridge Bank” with “Silicon Valley Bridge Bank”, the incredibly poorly chosen brand name for SVB’s interim successor entity.) Bridge Bank is still active in the market as a comparable to SVB. They offer standard banking services with a focus on startups and technology companies and have an active venture-lending arm.
First Republic Bank, which historically worked more with capital providers, real estate investors, and high net worth individuals, is trying to cater more to early tech companies directly. They are likely both to double down on their lucrative fund (VC/PE) lending practice as well.
PacWest (formerly Square1) and Comerica are the other established tech banks and both are still operating, although they focus on later stage and life sciences, so we see very few early stage software companies bank with them.
Mercury is a relatively new entrant that has garnered a lot of hype in the startup and tech market. Founded in 2019 and venture-backed by Andreessen Horowitz and Coatue, Mercury claims to be “not a bank” but bundles services from FDIC-chartered actual banks. They advertise “quick and simple” venture debt, but we have not heard of any deals or structures yet. During March 2023, they became a household name in early stage virtually overnight as fleeing SVB depositors chose them as a quick-to-onboard “plan B” – but it remains to be seen if they behave any different from other incumbents, credit-wise.
We have noticed over time that banks’ credit standards and activity in the market can swing dramatically based on the macro environment and internal politics (when Square1 and Bridge were both acquired, they withdrew from the venture lending market significantly until their new owners became comfortable with the underwriting models). All banks are likely to tighten lending standards even further in the wake of the SVB collapse (although again, SVB’s problem wasn’t with its actual loans)). Some banks may be leaning in aggressively to recruit SVB’s customers and borrowers, while others may operating very cautiously. It’s an uncertain time in the banking sector, so consider your “plan B” for if the FDIC’s unmarked vans pull up to your bank’s headquarters next Friday.
Non-bank venture lenders:
This category of debt providers includes Western Technology Investment (WTI) for short, Hercules and Horizon (recently acquired by Monroe Capital). They are the three most prominent non-bank venture lenders today.
They offer similar venture loans as tech banks, only perhaps larger: typically double digit million dollar term loans issued in conjunction with a double or triple digit equity round. These providers are the most likely participants to try to fill the high-end of the tech banking void. They already have a great track record and reputation – WTI lent money to Google in 1999 and Facebook in 2006, for example.
Pricing may be a bit more expensive than a bank, but they may provide more capital, with more flexible terms and covenants. Still, this underwriting model is heavily dependent upon having a fresh, well-known VC equity sponsor.
My firm, SaaS Capital, is a non-bank, alternative provider of debt to SaaS companies. Lenders in this category broadly serve the technology industry, but each has a unique focus, stage, target return, and deal structure. Examples include SaaS Capital, Espresso Capital, Lighter Capital, Level Equity, Element Finance, Recurring Capital Partners, and Runway Growth Capital.
Many providers in this category, including SaaS Capital, are unique in that they will lend to bootstrapped and lightly equity-backed companies. Many will also lend to companies with as little revenue as $50,000 per month.
Leverage ratios range from 2x monthly revenue, up to 2.0x annual revenue. Requirements can be more lax, but costs here are typically higher than at banks and non-bank venture lenders. Structures vary wildly in this category: term loans, royalty loans, lines of credit, and long duration bullet loans. Nearly every provider has a unique structure with its own pros and cons, so it’s important to model out any proposed structure and thoroughly understand the cash implications to your company
The SVB failure creates an opportunity for this group, and they will likely become more active and move into the SVB void. Because of the different strategies and structures, it is important for a potential borrower to do their diligence on the lender. Not every structure and capital source has the same capabilities and risks.
Particularly when considering any debt facility with a future commitment (like a line of credit or an option to make multiple draws in the future), it’s crucial for a potential borrower to ask about the lender’s source of capital, such as a public Business Development Company, a committed fund, or a warehouse lender. Find out where they get their money and how they make money to fully understand their incentives, economics and risk. A single-draw term loan is relatively “safe,” because once you get the money, you’re not relying on the lender to keep supplying more. But remember that a line of credit relies on the lender’s promise to fund you when requested in the future.
Subscription Cash Advance:
With the rise in subscription-everything (subscription heated car seats, anyone?), there has been a rise in ways to finance subscription businesses.
Companies like Pipe, CapChase, Founderpath, Float and Arc offer what we call “subscription cash advance”.
The concept is similar to traditional merchant cash advance: They will advance you 11 months’ worth of revenue upfront today, and then they will collect customers’ payments for the next 12 months. The twelfth month is their profit – I’m paraphrasing a bit here, but that is the gist of how most of these work. (If this all sounds a bit familiar to those who have followed revenue-based financing, it’s because it’s essentially a sped-up, aggressive variant of that model.)
To be a fit, your revenue model must be based on month-to-month payments. If you run annual upfront payments, you are not a candidate, because you are already “borrowing” 11 months upfront from your customers.
These advances can sometimes be a good deal, but the calculated interest rate is often in the 20s. Secondly, if you’re able to, convincing your customers to pay annually up-front would give you the cash flow without the cost. Even a 10% discount for upfront payments would be “cheaper” than using a subscription cash advance. (Discounts have other implications to consider, however).
Lastly, many of the subscription cash advance providers are venture-backed, high-growth companies themselves, so again, it is important to understand their own business model, how they make money and what their incentives are.
Below is a chart we built several years ago, but is still relevant today. Subscription cash advance is a new product since we made this graphic, but its place in the market and pros and cons are fairly clear.
The failure of Silicon Valley Bank in March, 2023 is far and away the greatest cataclysm in tech finance since 2001. The market is still recovering and finding its new equilibrium. As shown above, the remaining incumbents are fragmented across industries, company stage, strategy, and loan types. Lenders will evolve and new entrants will arise. Proceed cautiously and do your diligence on any possible financing partner over the next several months and quarters.
Your biggest risk as a borrower is whether a lender can honor its commitment to future availability. We usually think of the “risk” of debt financing being borne by the lender. But when you rely upon a lender’s line of credit, or multi-tranche term loan arrangement, you’re taking the risk that they will actually have the money when you need it. Not all capital arrangements are equal in this regard!
Some are wondering if the SVB collapse shows a particular danger in using debt to fund your business’ growth (those doing the “wondering” in public are often equity investors, oddly enough). Debt is a very cost-effective source of capital. If a company needs a large capital expenditure to exploit a risky, but very large market opportunity, then sure: selling equity is the best and likely only financing option. But if a company just wants to keep doing what it’s doing, only a little faster (hiring staff or expanding its AWS instances and spend), then borrowing money is a very good option.
I think everyone always assumed a tech banking failure would be due to a collapse in the venture loan portfolio. Interestingly, SVB’s early stage loans were generally performing fine. Debt, when deployed in an appropriate quantum and structure is a very powerful and safe source of growth-stage capital.
More information on the different venture debt options available to SaaS companies by SaaS Capital is below: