Will Your Startup Borrow More in 2022?
In 1968, Milton Friedman argued “In the Price of Money,” that higher interest rates don’t mean less borrowing. He would echo this sentiment in an article?Reviving Japan.
“After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high-interest rates and easy money with low-interest rates was dead. Apparently, old fallacies never die.”
Is this true in venture capital? As the Fed raises rates in the next few quarters, will startups borrow less? We’ve established that?interest rates are uncorrelated to startup financing?over the last twenty years. But what about debt?
Over the last ten years, venture debt correlates well with interest rates. At -0.5 correlation, interest rates explain about one quarter of changes in the venture debt dollars raised. The more expensive debt, the less of it startups seek. This goes against Friedman’s view.
What about the ratio of debt to equity? Irrespective of the environment, debt is always less expensive than equity because it’s far less dilutive. Given the low-interest rate environment, have startups shifted their share of dollars from equity to debt?
The ratio remains steadfast, hovering around 2% venture debt/equity dollars over the last decade. This affirms Friedman’s Fallacy. Rates and venture debt/equity ratio bears no correlation to rates.
In short, interest rates do influence how much debt startups seek in aggregate, but the ratio of debt/equity for each startups is relatively constant throughout time. At least according to this data, Friedman’s Fallacy applies at the macro-level, but not for each startup.
Managing Director at Coho Growth
3 年Great work as always Tomasz Tunguz. Your underlying question is if venture debt will be impacted by rate increases. I think yes to a certain degree. Lending businesses operate on "spread" while VC runs on "home runs". Lending sources capital from institutions that are affected by prime rate increases and will expect their returns to increase in relation to changes in prime. Institutional investors in Venture Capital, do not generally tie their returns to prime as they are looking for "home run" returns. To the extent that prime goes up, institutions with investments in venture debt will be expecting their GPs to pass those increases on to the debtors. However, there is in fact some upward ceiling on the ability to increase those rates (a topic for another time). To your correlation work....I think there have been structural changes in the debt market that impact the correlation... 1. There is far more venture debt available now than there was 10 years ago. I am wondering if your definition of Venture Debt goes beyond SVB etc. Grey market lenders, both long term (Timia, Element, SaaS Capital) and marketplaces with short term offerings (Pipe, Capchase) are a much bigger portion of the market. 2. As to the 1% to 3% correlation of Venture Debt to Equity, these debt providers also only target a certain portion of the market that matches up well with lending (generally B2B SaaS, B2C, Tech Services, IOT - anything with a recurring revenue stream and a relatively lower risk profile, but no assets). Venture moves from hot sector to hot sector, so I am not sure that the correlation is relevant. Put another way, VC is looking for the top 2% of deals, venture debt (tech lending) is looking for the next 50%. They are not targeting the same pool. Talk soon! Mike
Creating Predictable Proven Revenue Processes Daily
3 年Hey Tomasz Tunguz this might be the case for data relating to traditional venture debt lenders like SV Bank or others.. What do you think about newcomers like Pipe or LIQID? Does their model change the way VC think about venture debt?
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