When the founders of leasing and portfolio management company VTS needed money to grow their firm, they had two choices: find another investor, or take out a venture loan. Like a growing number of real estate tech startups, they chose the latter.
Venture debt, or business credit for startups that may lack the assets for traditional debt financing, has received little fanfare. But according to market players, its volume and importance to the real estate tech sector has grown significantly over the past year. “In a market like this, the numbers are very founder-friendly,” said VTS co-founder and CEO Nick Romito. “It’s a great thing for startup companies.” The firm, whose clients include SL Green Realty, Vornado Realty Trust and CBRE, ended up borrowing “several million dollars” from venture lender Silicon Valley Bank.
Venture loans typically carry one-to-four-year terms and come with interest rates ranging anywhere from four to 15 percent. Key lenders in the space include the venture banks Silicon Valley Bank and Square 1 Bank as well as the investment firm Western Technology Investment (WTI), according to insiders.
“These loans don’t generally get announced, so they are somewhat confidential,” said Charlie O’Donnell, head of the seed fund Brooklyn Bridge Ventures, an investor in real estate tech startups including Manhattan-based 3D software company Floored. “I would say that any company that’s doing well has probably gotten pinned by the banks already.”
Unlike venture capital, venture debt doesn’t require entrepreneurs to give up ownership stakes – a major advantage. “As a complement it can be very attractive if you’re looking to preserve ownership,” said David Eisenberg, founder and CEO of Floored and a partner at venture capital firm Red Swan Ventures. “You can get to the next milestone without losing too many shares.”
Floored is yet to seek venture debt, but Eisenberg said the firm is considering it for the near future. Reonomy, a real estate research and data startup based in the Flatiron District, is set to borrow in excess of $4 million from Silicon Valley Bank, according to its co-founder and CEO Richard Sarkis. He said that the firm, which has raised just shy of $20 million from investors, doesn’t have to tap into its debt line, meaning there are no costs if it ends up not needing the money. This flexibility also appealed to VTS, which hasn’t used any money from its loan yet, according to Romito.
Another advantage of this type of financing is that it keeps an exit strategy open for a startup’s founders, according to O’Donnell. Venture capital investors buy shares in the expectation that their stakes will balloon in value, and until then, are likely to resist any attempt by founders to sell the company. In contrast, entrepreneurs backed by venture debt can sell their companies at any price they see fit, provided they repay their loans. “This way I’m giving myself more exit opportunities,” added O’Donnell.
Venture debt comes with its own caveats, however. Interest and repayment can become a burden for fledgling startups, who sometimes burn through cash in the process of hiring and expanding. “The downside is it is debt, and you have to be confident about cash flows coming in,” said O’Donnell.
Because of these risks, venture banks are typically more conservative than venture capital firms. They mostly lend to firms that have already secured significant investment and produce steady revenue. VTS, for example, counts Blackstone Group among its major investors; Reonomy is backed by Bain Capital Ventures.
“We tend to follow the venture capital money as it goes into these startups,” said Brad Ellis, head of Square 1’s banking team in New York City. He added that he has been in contact with several startups in the real estate space. “I don’t have any of them as clients right now,” he said, “but I’ve definitely proposed taking out loans with us.”
According to Ellis, interest rates on Square 1’s loans are typically between 4.5 and 6.5 percent. He explained that many borrowers don’t even draw on their debt lines, and merely use them as an insurance policy. “It just gives them the time and comfort to grow their companies,” he said.