“Do you think companies in Silicon Valley should take more debt?” Chamath Palihapitiya, Founder of Social Capital, asked me bluntly during an interview in Mountain View a few months ago.
We were at the headquarters of one of Chamath’s most promising climate tech startups – Mitra Chem – perched awkwardly around a table on the factory floor surrounded by millions of dollars of state of the art equipment. We were discussing Mitra Chem’s eye-watering $40 million Series B.
Chamath continued: “The classic Sand Hill thinking is companies should never have venture debt, as all of that stuff is basically poison— it will poison the cap table and eventually come back to bite you.”
Seconds later, Vivas Kumar, the Founder & CEO of Mitra Chem, jumped in:
“We were weeks away from raising our Series B and needed bridge financing to hold us over. We approached several traditional banks but realized that we couldn’t complete the process in time. Ultimately, we approached a Fintech, who quickly got us the millions in capital we needed to stay focused on closing the equity round.They saved our company.”
Vivas’s story is not uncommon in Silicon Valley, particularly following the venture capital funding crash, which has stretched into 2024. The cash-burning startups that relied on VCs were forced to reverse their unit economics overnight, and those that couldn’t, looked elsewhere for funding—turning to the banks. But following the regional bank crisis, traditional banks were nowhere to be found.
When Silicon Valley Bank collapsed less than a year ago, it had been the uncontested leader in venture debt for decades. Since then, venture debt volumes have plummeted nearly 40%. Startups are in the market, but banks simply aren’t providing the funding. The venture debt gap widened further in 2023, with demand reaching all-time highs and supply plumeting to all-time lows.
The result? A tech liquidity crisis with no end in sight.
Despite the pullback from the old guard, private lenders remained optimistic. In fact, the market opportunity couldn’t have been more perfect for new entrants to compete: the collapse of the market leader in tech banking, heightened demand for capital by startups amidst the Venture Capital drought, and strengthening unit economics of resilient startups who were finally prioritizing unit economics over “growth-at-all-costs.” Dozens of new lenders emerged to fill this gap, including credit funds, family offices, and banks like HSBC and Stifel. who absorbed dozens of bankers from SVB.
Tom Smith, VP at HSBC Innovation Banking, shared his perspective with Sifted:
“A couple of years ago, we were getting beaten out by equity. VC money was so cheap and easy to get that founders were not interested in taking loans. But now capital is much more scarce and expensive, founders are looking for alternatives to traditional venture capital.”
Tom’s right.
When equity dollars were flowing, many founders didn’t see the value of raising debt. And in 2021, why would they, when founders could snap their fingers and raise a $50 million equity round with neither customers nor revenue? Not to mention, the VC investors on their Boards discouraged founders from raising debt. Is that because debt is poison for startups? Or is debt simply a competitive threat to venture capital? After all, debt is a cheaper substitute for equity, particularly at today’s valuations. And let’s not forget, VCs face mounting pressure from their Limited Partners, with record levels of dry powder to put to work.
To be clear, debt can be dangerous if you overindulge. And it’s not for everyone.
Unnecessarily burdening your balance sheet widens the pref stack and introduces the risk of insolvency. Look no further than WeWork ($47B valuation at its peak), Olive AI ($4B), Veev (+$1B), and Bird ($2.5B) all of which filed for bankruptcy after being fueled by the Fed’s cheap money policy. They went from ZIRP unicorns to fallen angels overnight. But done right, debt can also be the lifeline that saves a startup. Or even accelerate a startups growth at a significantly lower cost than equity. Just ask Mitra Chem, or the thousands of other startups who relied on debt capital to weather the storm in 2023.
Back to the question: should startups consider debt in 2024?
Let’s just ask Chamath. Who by the end of our discussion conceded:
“If we could use [debt] for all corporate purposes, if the milestones were very clear… that dilution is still so much less than a Series B. At that point, [debt] makes a ton of sense.”
As we sat in a factory surrounded by disruptive EV battery technology — largely financed with low cost debt capital — I reflected on Chamath and Vivas’ words: the real problem isn’t the debt itself; it’s whether it’s structured and deployed responsibly by the startup and its lenders. While venture debt is not a fit for every business, it isn’t poison either. Venture debt needs to innovate alongside the innovative companies it’s serving.
Sounds like a perfect opportunity for a bit of financial innovation – an opportunity that Fintechs are perfectly positioned to serve – which the now fragmented lender universe has never been more ready for.