The default rates in venture debt lending typically range anywhere from 1% in a really good fund to 5% to 8% in a tough startup environment. The difficult thing about venture Landing is that it’s very cyclical.
When venture-capital equity is plentiful, the venture debt default rate goes down dramatically because the marginal company will still get funded. I’ve seen it happen many times. A company will be on death’s door, and a strategic investor or new fund will rescue the company. It’s a beautiful thing if you are the lender and equity syndicate.
In tough times, you can’t count on being rescued in a bad deal. Money is way tighter, the tourist funds are not coming around and the only way to get the company funded is by convincing one of the usual VCs to step up.
If Insiders are not stepping up and a new source of funds can’t be found, then the startup must cut the burn and look for an acquirer. This path is also tough in a downturn, because acquirers are much less likely to take on cash flow burning companies. Often times those big acquires have just laid off 5 to 10% of their own workforce. Why would they want to take on someone else’s problem child that’s burning cash?
For these reasons you see a lot of default rate variability across fund vintages. One fund may time an upswing perfectly, while another may be stuck in a trough for a long time. Over time though, venture lending is a terrific asset class to invest in. You can get a solid 8% - 12% annualized return. There are very few debt asset classes with that kind of predictability and return profile. (Learn about how to raise venture debt for your startup here.)
Then one key to investing in venture debt is to invest in a team that has access to deal flow. Lenders who don’t have access try to buy it with aggressive deal terms and they usually only get the worst companies. That’s a recipe for losing money.
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