The rise of venture debt: When biotechs should—and shouldn't—use it

Biotechs are operating on razor-thin margins, struggling in a market that just two years ago was flush with cash for big ideas. But now, these same companies are facing more desperate times and seeking out innovative ways to extend their cash runways. There's a time and a place for everything, and right now might be the time for venture debt.

In the simplest terms, venture debt is a loan for companies that have raised money from venture capital firms. Often used by fast-growing or early-stage companies, venture debt can offer flexibility other financing forms can’t. The funding is nondilutive, meaning businesses don’t have to lose equity for it, and it can also be used to extend a company’s cash runway. And extending cash for operations by even a few months or quarters has been top of mind for biotech investors everywhere over the past year. 

Historically, venture debt was used mainly as a financing mechanism for startups that had line-of-sight to revenue so they could shed the debt shortly after, Vineeta Agarwala, M.D., Ph.D., general partner at venture capital firm a16z, explained during Fierce Biotech’s capital market panel Jan. 10. However, the market environment has changed significantly in recent years, with biotech drawing in venture debt at much higher levels than two years ago, she said.

That trend holds true for the entire market as venture loans grow with the VC market. In 2021, 3,691 venture debt deals were made in the U.S. totaling $32.7 billion, compared to 2,586 deals worth $15 billion in 2016, according to the PitchBook-NVCA Venture Monitor (PDF). 

As for 2022, more than $20 billion in venture debt was invested in biotech and pharma through the end of the third quarter, or Sept. 30, according to the Pitchbook-NVCA report. Analysts noted that biotech and pharma deal values were still growing, and an increasing proportion of the deals were made by late-stage VCs.

Recent venture debt loans in biotech

ExeVir Bio received $26.5M from the European Investment Bank Release
Evelo Biosciences received $45M from Horizon Technology Finance Corporation Release
Enveda Biosciences raised a $68M equity and debt financing series B; Silicon Valley Bank provided the debt facility Release
Atai Life Sciences entered a term loan facility for up to $175M with Hercules Capital Release
Tricida received $125M debt facility from Hercules Capital Release

“I absolutely am a believer that venture debt, venture credit, has a much bigger role to play nowadays than it had five years ago,” Sofinnova Partners Chair and Managing Partner Antoine Papiernik told Fierce Biotech on the sidelines of this year’s J.P. Morgan Healthcare Conference. He cited two reasons for this: Investors are more willing to do it now, and VCs have plenty of cash on hand.  

In today’s climate, venture debt can be a good option for biotechs, particularly if it's used as a bridge to somewhere, Papiernik said.  

“The fundamental reason to do it is that it's potentially—potentially in stars—a less dilutive way to get to the milestones required for your next equity fundraise,” Agarwala said.

“There's a time and a place for venture debt,” Abbie Celniker, partner for Third Rock Ventures, said during the Fierce Biotech event. “But it should be used incredibly carefully and it should never be a substitute for equity financing.”

That’s because the funding vehicle comes at a cost. Overall, U.S. venture loans dropped from $9.7 billion in the second quarter of 2022 to $4.7 billion in the third quarter as borrowing became more expensive, according to PitchBook-NVCA Venture Monitor. As a possible global recession looms, venture investors may be tightening up the purse strings.

Agarwala underscored the amount of risk involved with this type of financing, particularly if there’s a chance a biotech won't hit clinical endpoints or is still waiting on data that will significantly impact its ability to fundraise. Overall, she believes it should be considered as part of a much broader financing strategy and capitalization plan and should be tightly tied to value creation milestones.

Another issue arises when it comes to attracting new investors, who aren’t interested in covering a company’s debt, Celniker said.

“That's not what they're coming in for,” Celniker explained. “Depending on the size of that debt, it can actually be a huge deterrent to subsequent finances.”

While Celniker thinks venture debt can be helpful when used for something that creates more value in the short term, she did warn against biotechs using it as a bridge to the next equity financing if they’re not certain what upcoming data will look like.

“It can turn out to be extremely dangerous for companies,” Celniker said. “In some cases, it can even be something that could bring a company down.”