When David Rabie first introduced Tovala in 2017, which combines a smart oven with a food delivery service, the concept was a touch out there. Then the epidemic struck, and the concept caught on. As an alternative to selling shares of the company, he has raised about $100 million for the Chicago-based company and has borrowed a small amount of venture loan from Silicon Valley Bank. That made it possible for him to grow Tovala, which today has three food plants in Illinois and Utah and 350 employees.
“SVB granted us money while the business was highly unprofitable and early stage,” Rabie tells Forbes. If SVB had not given us the money during the Series A [venture-funding round], “a lot would have changed. Other banks were not interested.
Rabie is only one of many business owners that obtained venture debt from the largest issuer, the defunct Silicon Valley Bank, as debt funding for venture-backed firms increased. According to the Pitchbook-NVCA Monitor, the utilization of venture debt increased to $32 billion in 2022 from $7.5 billion in 2012, a more than four-fold rise. SVB contributed $6.7 billion to that issue in the previous year. Rates on it ranged from 7% to 12%, and it also included warrants that gave the lender a chance to acquire a minor equity part in the company.
When Silicon Valley Bank failed over the weekend, entrepreneurs and investors have been concerned about what would happen to their existing debt. Founders who had taken out venture debt with SVB were concerned that if they pulled their money out of the bank they may be in violation of loan covenants forcing them to keep cash there as fear spread during the bank run. Some are now speculating about who might purchase the debt — private equity firms like Apollo Global Management have reportedly expressed interest — and ultimately obtain a minority ownership in their companies. Matt Michaelson, founder and CEO of Smalls, a high-end cat food firm that took on a mystery investor, says: “It's a little unsettling that you're delivering investor updates to a mystery player.”
In a broader sense, the question is what will happen to this market, which has been expanding quickly but largely unnoticed, in light of rising interest rates and investor apprehension. Jeff Housenbold, a former CEO of Shutterfly and a venture capitalist at SoftBank who now runs his own investment company, Honor Ventures, predicts that venture loans will become more expensive. Businesses who are fragile won't be able to raise financing, according to the statement.
The company operating under FDIC receivership is known as Silicon Valley Bridge Bank, and on Tuesday, Tim Mayopoulos, the new CEO, stated in a memo that the bank will be “making new loans and fully honoring existing credit facilities.”
That put some immediate worries to rest, but it doesn't address the more pressing issues.
Take Rajat Bhageria, the creator and CEO of Chef Robotics, as an example to see how inexpensive this money originally was. In December 2021, he obtained a $2 million loan facility from SVB at an interest rate that was only 50 percentage points above prime, or 3.25% at the time. This was an incredibly low cost of capital for a robotics firm. Clearly, prime has undergone significant transformation, he claims. It was quite low at that point, and people were asking themselves, “How in the world are we receiving this?”
The venture finance was very helpful for a robotics company because capital expenses are significant, and Bhageria still sees it as beneficial even though the prime rate has increased to 7.75% and increased his borrowing costs. Many people have expressed issues regarding venture debt, he claims. They advertise it as a “runway extension”—the period of time during which the company may continue running without obtaining more funding—but this isn't quite accurate because you'll soon have significant monthly debt obligations.
The cat food CEO, Michaelson, has a $4 million debt arrangement with SVB and has raised around $30 million in equity. In light of SVB's failure, he claims he is reconsidering the financing of his business. He claims that when the bank run started, “our investors were putting a lot of pressure on us to move our money out.” But he was concerned about the loans going into default. When he eventually attempted to withdraw money, the transfers failed as a result of the increase in demand. Even though everything has passed, the incident made him reconsider.
He confesses, “I do worry. “We discuss whether to refinance the debt elsewhere. What does the debt market do, and will there be this kind of loan available? Less debt will be available as a result of the wind's direction, and those who are less likely to obtain it will certainly feel the pinch.
Michaelson claims to have just heard of a founder of a firm in a comparable stage receiving a term sheet for venture debt with a 13.5% interest rate. That's much higher than what we're considering, he remarks. “It loses its allure at a certain interest rate. You are contrasting debt with equity as well as comparing debt to debt. It may become less competitive depending on the direction values take in the venture markets.
Non-bank lenders have been vying for increased market share in the venture financing market ever since SVB's demise. Arjun Kapur, managing partner of Forecast Labs, a startup studio that is a subsidiary of Comcast NBCUniversal, notes that while SVB did have a concentration of startups, it wasn't so concentrated that there wasn't a place where you could find an alternative.
As always when it comes to funding, risk and cost are the main concerns. People are risk-averse, thus it's pricey right now, according to Housenbold. Since there would be less venture debt in the beginning, founders will have to absorb more dilution. The venture capitalists are going to make more money, and the founders will own less of the company.”