Growth equity investors are getting a chance to invest in startups at a discount.
Startups have been facing a liquidity crunch since last year, when the fundraising environment became tougher and companies struggled in a deteriorating economy. But the collapse of Silicon Valley Bank in March may push some of these companies to raise capital from growth equity funds. In recent years, founders have favored debt over equity, which doesn’t dilute their shares.
“Any disruption like this creates opportunity, and private equity is usually very well positioned to take advantage of dislocations,” said Jeff Diehl, managing partner and head of investments at Adams Street. “With SVB’s instability, the alternatives are really just equity now, predominantly because SVB had a very big market share of venture lending.”
According to data from PitchBook, Silicon Valley Bank issued $6.7 billion of venture debt last year — more than 20 percent of the total issued in 2022. Private credit managers may fill some of the gap left by SVB, but founders may be deterred by rising interest rates and floating-rate private loans.
“The conversation before was that debt [allowed] less dilution for the founders” and better returns for investors, said Maëlle Gavet, CEO of Techstars. But the fall of SVB has changed the tradeoffs. “I don’t think it’s a question of founders [losing] confidence in the banking system. I think it has to do with the actual available options for founders,” she said.
Growth equity dealmakers were already thriving before the collapse of SVB. According to Jinny Choi, private equity analyst at PitchBook, growth equity deals usually don’t make up more than 20 percent of total private equity transactions. But they accounted for 22 percent of all PE deal value in the first quarter.
“A lot of investors are leaning toward smaller deals,” Choi said, adding that it’s easier for investors to write smaller checks in an environment where capital is scarce.
In terms of the valuations of future growth equity deals, investors expect to see a bifurcation between companies that have already started to generate positive cash flows and those that haven’t reached that point.
“Companies that are generally in good industries and are close to breakeven or managing their cash flows are going to attract good valuations,” said Nitin Gupta, managing partner at Flexstone Partners, a private equity firm focused on the lower and middle market.
But for companies that won’t be profitable for the next few years, growth equity investors will more than likely get a discount. “They’ll probably have a harder time raising capital or [negotiating] attractive terms,” Gupta said. “We’ve already seen valuations correct for these companies.”