Given the lackluster returns in traditional fixed income markets, the venture debt strategy has been gaining recognition from institutional investors, including pensions, endowments, foundations, and family offices, for its ability to produce outsized returns with surprisingly low risk.
Venture debt includes debt products for companies that have previously received institutional funding from venture equity investors. It is typically structured in the form of short duration, floating-rate senior secured term loans combined with equity warrants. This mix provides the lender, and investors, with current income, capital protection, and unlimited potential return.
“The opportunity in venture debt expanded significantly following the Global Financial Crisis, when new capital requirements and tightened regulations made holding corporate middle-market loans more expensive and restrictive for bank lenders. This led to non-bank lenders stepping in to fill the demand. This structural shift, combined with the significant increase of innovative early-stage companies seeking financing, has provided fertile ground for the growth of the venture debt market,” said Zack Ellison, A.R.I.’s Managing General Partner and Chief Investment Officer.
A.R.I. estimates that non-bank venture debt lenders returned over 20% annually from 2005 to 2019, a period that includes the worst years of the Global Financial Crisis during 2008 to 2010. During this 15-year period, loss rates averaged less than 0.50% annualized.
“Despite the COVID pandemic, the strategy performed very well in 2020 and A.R.I. anticipates that the 2021 and 2022 vintage years will be among the best in venture debt history,” said Ellison.
In addition to the attractive risk-adjusted returns provided by venture debt, investors benefit from security of capital, strong portfolio diversification, no interest rate risk, low volatility, limited “J-Curve” effect, and the opportunity to co-invest. Read the full paper here.
About Applied Real Intelligence LLC (“A.R.I.”)
A.R.I. is a venture debt investment manager focused on providing financing solutions to innovative, high-growth, VC-backed companies operating in recession-resistant sectors and underserved regions throughout North America. To view A.R.I.’s recent issue of the “UNCOMMON CENT$” newsletter click here. To learn more visit https://www.arivc.com/.