It is understood that not only will raising venture debt become increasingly difficult for the sector, but InsurTech companies will also struggle to access their credit lines. This capital had allowed many firms to operate at a loss, after extending runway by aggressively trimming down costs and shoring up liquidity with debt.
“You’re undoubtedly speeding up the crash, as you’ve removed one of the easier ways for people to access capital,” one market source said. “People are now going to run out of money faster. They’re going to have to figure out solutions much faster than if venture debt was still easily accessible.”
On Friday, the California Department of Financial Protection and Innovation closed down SVB, a key provider of capital for technology start-ups, sending shockwaves throughout the venture capital community. Two days later, state regulators closed New-York-based Signature Bank. The Federal Deposit Insurance Corp (FDIC) was appointed as receiver in both cases, according to statements.
Sources immediately expressed concerns over InsurTech SVB banking clients not being able to make payroll on March 15th. But those fears have now been assuaged, as the US Treasury Department and other regulators guaranteed that all depositors would have access to their money by March 13th.
But market sources noted that concerns don’t stop there, as SVB was one of the major providers in the venture capital community.
In December, this publication wrote that raising venture debt had become increasingly popular among InsurTechs. Sky-high private InsurTech valuations cratered, as a combination of pulled IPOs and punishing market conditions for public InsurTechs created downward pressure.
As a result, the market saw companies more prominently take on debt to supplement equity rounds, or borrowing in between rounds to preserve liquidity and avoid down rounds.
Now, with the implosion of SVB and Signature Bank, sources agreed that there are two dynamics at play which could significantly shape the InsurTech landscape going forward.
Firstly, InsurTechs may now have trouble accessing their existing credit lines to keep day-to-day operations afloat. And secondly, opportunities to borrow will dwindle, and companies that relied on raising venture debt as a liquidity lifeline will have to push harder to reach profitability, or else they will ultimately wind down or become a distressed M&A target.
“We are entering a very ‘no-risk’ economic environment,” one investor source said. “Banks want to lend, but I don’t think anyone is going to have the stomach for the model that SVB had. My feeling is that venture debt is going away right now, and all players in the sector are going to take a step back.”
‘Evaporating’ credit lines
While cash deposits are guaranteed to be honored, there is currently little clarity around what will happen with SVB/Signature credit lines, which InsurTechs had been relying on for working capital needs amid a wider equity capital dry spell.
Yet sources speaking with Inside P&C agreed that undrawn credit lines are likely to “evaporate”, and that many startups in the ecosystem will see their runway cut by three or four months.
“In the case of SVB and Signature, consider any undrawn amount in your line of credit gone,” one InsurTech chief executive said.
Sources also noted that funds in many InsurTech venture debt deals are structured in tranches, where the total loan amount was spread into separate portions to be drawn over time as the business achieved certain milestones.
“Let’s say you draw on $10mn, and you have a $5mn tranche that you want to draw on next year. No one that is going to buy up that debt is going to honor those secondary tranches,” one source said. “All these companies that thought the deal was done are not going to be able to access the debt they were hoping to access.”
There is also another dynamic at play around material adverse change (MAC) clauses, which were part of many venture debt deals done with banks. A MAC clause can act as a “get out of jail” card for lenders, sources noted, as depending on the parameters of your agreement, it can trigger a lender to call your debt if there is a change in the business environment.
“This is the type of situation where you see MAC clauses being triggered, especially with the interest rate environment and the systemic risk associated with the sector,” one InsurTech executive said.
Sources added that this could have ripple effects with other banks that lend to InsurTechs, as many of those deals have MAC clauses. If something material happens, the bank is allowed to stop lending to a company, or even potentially demand repayment of the debt. It all depends on the language of the clause.
It is also understood that banks other than SVB had already started triggering MAC clauses to call in InsurTech loans even prior to this weekend’s events.
“If all of a sudden someone says that they are pulling your line, and not lending you any more money, or that you need to pay back now, that is going to put a lot of strain on startups that are not cashflow positive,” the source continued.
Venture debt dries up
Sources said many companies are ultimately going to fail because they can’t access their credit lines in the short term and won’t be able to raise debt going forward.
Sources noted that this scenario has wider implications for the InsurTech capital-raising landscape, as the dwindling of debt will push companies to crowd an already-hard equity market, leading to even more supply and demand imbalances.
For context, global InsurTech investment fell to $1.01bn in Q4 2022 – its lowest level since Q1 2020 and a 57% drop from Q3 2022, according to the latest edition of Gallagher Re’s Global InsurTech Report.
“It’s going to spur people to raise capital earlier, because they lost funding from not being able to access additional tranches of debt, and we will see more layoffs and expense management,” said one InsurTech source.
And as companies hit a wall with both accessing and raising debt, sources said they will flock to the equity markets, which have already dried up. Therefore, we will inevitably see companies have to wind down or become acquisition targets for distressed M&A, they added.
Sources also noted that any deal currently in motion between term sheet and closure is under pressure. Every investment committee is going to hesitate, and they are probably expecting that they can now get in at a cheaper valuation, given the backdrop.
“If you were planning on doing a financing round in the next six months, you are definitely concerned,” one InsurTech executive said, though they cautioned that “if you were planning on doing something in Q4, you are not in ‘full freak-out mode’ like if you needed money by Q2.”
It’s going to spur people to raise capital earlier, because they lost funding from not being able to access additional tranches of debt, and we will see more layoffs and expense management
The ‘cleanse’
Sources agreed that the SVB collapse has accelerated a process that was already underway, as the InsurTech sector is facing a tough correction period.
“Companies that were already using venture debt as a lifeline, they rarely would have turned into a success story anyway,” one investor source said.
“As soon as equity investors said they weren’t interested in those business, that was [the] death of them,” the source continued, adding that using venture debt as a lifeline was never a way to materially fix a business for the long haul.
Another investor described the SVB episode as “the last shoe to drop”, going on to say that despite venture debt’s recent prominence, it was already in the process of “going away”. As the broader economic climate changed, debt became more expensive and venture debt lenders began to be much more thorough in their due diligence.
“This was already happening before the weekend, and I’m sure now it's going to be much tougher,” the source said.
People who were holding on with venture debt are now coming to the end of that, and though it will be painful for a lot of people, it should force a lot of smart minds to come back into the market with projects that have the unit economics in place – if they take the learning experience
But sources agreed that as venture debt gets restructured, called, or ultimately pulled back, this should be a significant transition point for the industry – a moment of “reckoning” which some compared to what happened during the dot.com stock market bubble in the late 1990s.
“Good companies survive and become fantastic companies," one investor source said. “But there is just so much garbage in the market. A year ago, it was hard to say this, because everyone was chasing everything.”
Sources noted that companies with strong fundamentals will raise venture capital and continue to prosper, even if at lower valuations.
“It is going to be a cleanse,” one investor source said.
As for the companies which ultimately wind down, one investor said that also could provide an opportunity for the InsurTech sector, as we will see founders exit the space and potentially return with more economically viable ideas.
“People that were holding on with venture debt are now coming to the end of that, and though it will be painful for a lot of people, it should force a lot of smart minds to come back into the market with projects that have the unit economics in place – if they take the learning experience,” the source said.
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