Welcome to Capital Advisors Group’s inaugural quarterly newsletter that will provide a snapshot of the current state of the debt financing markets. Capital Advisors Group has been advising innovative venture-backed and growth-stage companies on debt finance transactions for more than 18 years. This newsletter will provide insight into debt markets, specifically as they relate to prominent trends in venture debt and lower middle market transactions. On a quarterly basis, we’ll review the market as a whole and how it stacks up to equity financing trends. We’ll also break down the market on a broad sector basis and assess the health of the market―tracking publicly available data on impaired debt, troubled debt, and loan defaults at banks and debt funds.
For the past decade, the US venture debt market has boomed, growing nearly every year on a volume (number of deals) basis. Over the course of 2021, the market reached a record number of deals with more than 3,600 completed across all sectors. However, the market bucked the growth trend in capital raised in 2021, dipping slightly, just more than 2%, from the prior year. This may have been due, in part, to a dramatic drop in deal flow in the healthcare sector in the second half of 2021. Unsurprisingly, deal volume has dropped 20% year-over-year through Q3 2022 in parallel to the pullback of both private and public equity markets. Finally, as we review debt as a percentage of the venture equity markets, the numbers held relatively steady from 2012 to 2020, averaging just over 15%. However, that number dropped to 8.7% during the record setting equity financing levels in 2021 and hasn’t recovered to prior years’ levels through Q3 2022. In fact, venture debt deal value dropped dramatically, more than 50%, between Q2 and Q3 this year and, according to Pitchbook, reached a five-year quarterly low point of $4.7B in total fundings in Q3.
Sector Activity – A Tale of Diverging Markets
Not surprisingly, in 2021, the healthcare sector’s venture debt deal flow fell significantly, nearly 13%, from its 2020 peak in terms of total dollars. The presence of record equity financing in this sector likely drove this 2021 trend because it supplanted the need for debt financing in many cases. However, the equity markets in life sciences began to slow considerably toward the end of 2021. The slowdown has persisted through Q3 of 2022, which has dramatically affected lending. Year over year, healthcare lending has fallen 17% in dollars raised. Additionally, many lenders have tightened their credit requirements, and deal flow in the first half of this year has fallen to its lowest level in five years, dropping nearly 25% from the same time last year.
In contrast to the healthcare sector, the technology sector enjoyed a record year in 2021 for debt financing and has continued that trend through Q3 2022. As of 9/30/2022, the market crested $20B for the fourth year in a row and that mark was 20% higher than this time last year.
Deal values are growing in the technology sector and may reach another record in 2022. Over the past decade, total annual deal value in the technology sector has grown by nearly 5X as the sector has embraced debt financing as a non- or less-dilutive form of growth capital.
Finally, through Q3 2022, an emerging market trend is revealing that funds have begun to focus investments slightly toward later stage companies.
CAG Market Health Index
Capital Advisors Group has developed a market health index of publicly available market information to provide a broad assessment of the health of the debt finance industry. Historically, default rates have remained well below the 10-year trailing US speculative grade debt average default rate of 3.4%* and both bank and debt fund default rates have been on a downward trend throughout 2022.