Venture debt is a commonly generalized, nuanced credit instrument. SQN Venture Partners calls for providers to resist the urge to place venture debt into the ambiguous category of private credit.
A commonly used phrase in the world of business is “You have to spend money to make money,” which refers to the necessity for businesses to remain well-capitalized – and therefore well-equipped – to adequately scale and drive profitability. In reality, many founders do not possess an unlimited pool of resources to pour into their businesses, turning to borrowing and raising capital as a result.
In many cases, the simple solution is to obtain a business loan. However, most venture-backed organizations are unable to access traditional bank loans due to their atypical credit profile. These businesses are also not quite ready to be publicly listed on capital markets or to issue bonds – leading them toward ‘private credit,’ which is a catch-all term for loans considered outside of traditional banking.
Some types of financing classed as private credit include real estate debt, distressed debt, direct lending, mezzanine debt, and special situations.
Venture debt is an instrument often availed by companies in the emerging technology space and is often considered under the “private credit” umbrella. Equity investors and entrepreneurs use this type of debt to maximize enterprise valuation and explore the appropriate amount of debt intended to accelerate growth. Despite the risk, investors typically invest in this due to the yield generation and potential upside from warrants.
Nicholas Barnett is the co-founder and executive vice president of venture debt provider SQN Venture Partners. He argues that as a term, ‘private credit’ encompasses such a large and diverse number of instruments, that grouping them together may be counterproductive for investors – because of this, venture debt should not be placed into the private credit classification.
“I don’t think there is a lot of benefit for the domestic US wealth management community when something is labeled as private credit,” Barnett says. “There’s so much nuance that when asset classes such as venture debt get dumped into this private credit bucket, it doesn’t really give you any identifying key features. The other day, I saw a financial analyst on TV say that they were weary of how private credit will be performing over the next year. I disagree with that on a fundamental level, because I believe that it’s impossible to extrapolate from the entire ‘private credit’ universe, consisting of so many different companies –some are private equity backed, some are venture capital backed, and some don’t have any backing. It’s just too varied, and it rubs me the wrong way every time I hear somebody speaking about private credit as a whole and providing guidance on negative and positive trends.”
Due to the ambiguity of the term, ‘private credit’ may hurt the ability of investors to differentiate the variety of instruments available. In fact, various asset classes that are lumped together as private credit, often involve drastically different risk profiles.
“The huge variations in risk profile make it so that using the term private credit is often not beneficial,” Barnett says. “Private companies come in so many different shapes, sizes, and potentialities of success that dramatically change the perceived and implied risk of that company’s success during the loan exposure. Thus, the term ‘private credit’ becomes useless, as you’re not able to differentiate. The term isn’t very descriptive, and there’s no single risk and return and profile to speak of, because of how many different types of companies are being placed into that bucket.”
