Alternative financing creates a path to VC funding

On Jul 22, 2022

The down market in VC dealmaking is proving to be a boom time for venture lenders.

Until earlier this year, it was relatively easy for startup founders to obtain new capital at high valuations for their companies. But in today’s bearish conditions, it’s now commonplace for investors to assign them lower valuations alongside more stringent deal terms.

The result has been that startups in need of extra cash are turning to less punitive funding sources such as venture debt and other forms of non-dilutive financing.

“We have become one of the most attractive [financing] options,” said Harry Hurst, co-founder and co-CEO of Miami-based Pipe, a marketplace for selling and buying recurring revenue streams. “It’s showtime for us now.”

Revenue-based financing has emerged as an especially appealing capital alternative for startups with contractual or predictable sales models. Companies that lend upfront capital against startups’ recurring revenue say they have seen a surge in demand since the beginning of the downturn.

Fintech startup Capchase is another provider of non-dilutive capital for software startups. Miguel Fernandez, Capchase’s co-founder and CEO, said that his company could play an important role in helping startups avoid down rounds.

Startups now have two paths to reaching their pre-correction valuations, he said: They can grow as fast as possible or slowly, but for a more extended period.

“Both options need more money,” Fernandez said. “Companies can get venture debt or Capchase with the hope it [will help them grow] into their valuation.”

Capchase has raised over $760 million in debt and equity since it was founded two years ago and was valued at $780 million earlier this year, according to PitchBook data.

Capchase and Pipe claim that their offering is superior to traditional venture debt because their lending decisions are data-driven and, therefore, can be made quickly, while receiving funds from venture debt providers could take many weeks. Additionally, once a company’s revenue grows, its credit line is increased automatically.

“Every customer, on average, grows around 60% faster with Capchase than before us,” Fernandez said.

That’s because companies that invest their loan into growing their top line receive additional funding, creating a virtuous growth cycle.

When Seattle-based Picket, a residential property management platform, was looking to enhance its $7 million Series A round with venture debt earlier this year, the team collected quotes from four venture debt providers, including Capchase.

“When you looked at the total cost of capital, Capchase offered the most competitive terms,” said Shaun O’Connor, Picket’s CFO. “And as we continue to grow, Capchase grows with us.”

Startups and boot-strapped companies of all sizes are taking upfront capital from Pipe, Capchase and Founderpath, an Austin-based company offering a similar product.

Pipe, which was valued at $2 billion last year, says that it provides capital to companies with as little as $100,000 in annual recurring revenue, up to publicly traded companies with over $1 billion in revenue.

Although the cost of borrowing from these lenders may go up in a rising rate environment, Capchase and Pipe said that the average cost of using these solutions has not increased since last year. Capchase’s fee, which is similar to an interest rate, ranges from 4% to 10%.

However, Matt Burton, a partner at QED and an investor in Capchase, said via email that alternative lenders are becoming more discerning. “The number of loan applications has gone way up, but the risks are higher in this rising rate environment, so approval rates have decreased.”