Growth and later-stage venture loans to high-growth companies are garnering greater interest as institutional investors take a more granular approach to private credit and seek out differentiated returns. The slowly improving macro environment has created an opportune time for growth lending. There has been a material bifurcation in this market between high-flying companies on one hand, and a broader market where equity is less of a fit but additional capital is still critical. In this landscape, there are a material number of proven growth companies that are still well suited to debt. However, it takes an experienced debt manager to identify and fund the right credits across this wide field, to manage a robust growth-lending portfolio through all market cycles and to deliver consistent, attractive risk-adjusted returns, as Jeff Bede, head of growth capital at ORIX USA, explains.
Pensions & Investments: After flourishing for more than a decade, the growth industry has been facing a downturn. Where is the market now?
Jeff Bede: For more than a decade, we had a bull market in venture capital, where thousands of companies were getting funded, and valuations were high. Since 2022, the market has bifurcated, and new equity raises have been more limited to a select group of companies, but there is a part of the marketplace still deserving of growth capital. Many of these companies have seen pressures from lower spending in enterprise technology, longer sales cycles, or lower renewal pricing (down-sell) that has resulted in slower revenue growth, and the cost of equity for them has also gone way up. But we still see a robust pool of companies with proven, sustainable business models at revenue scale, but currently not growing at rates that attract or justify the cost of venture equity. It has created a lot of opportunity where debt is a good solution for solid businesses that still have need for capital. Growth lending is also an underserved market, creating a compelling opportunity for lenders. From an investment opportunity perspective, I believe there are strong reasons for institutional investors to consider the asset class at this time.
P&I: Why should institutional investors consider growth capital today?
Bede: I see growth lending starting to go prime time with institutional investors, instead of being a niche sector funded by specialty lenders. It also happens to be a good time to enter the market for several reasons. Returns are higher than other mainstream direct lending asset classes, and secured, well-structured loans are designed to provide meaningful downside protection. The proprietary origination and the specialized nature of the underwriting relative to other debt sectors means that investors can potentially achieve strong risk-adjusted returns. We now have decades of performance data that has been tested through a range of cycles and our target companies have been especially “battle-tested” over the past few years. Loss rates are low.
Growth lending also provides a high cash coupon that provides current income from day one. Being senior in the capital structure meaningfully reduces the dispersion of outcomes compared to growth equity capital. In our opinion, it’s an attractive way to play the most dynamic and growing part of our economy, with attractive returns and debt-like protections, and in what we believe is a safer and more predictable way than venture equity. From a diversification point of view within private credit, I believe this sector is less correlated than other parts of the debt markets. For institutional investors considering the asset class, it is key to work with an experienced manager to navigate this market, as the origination and underwriting is more specialized, leading to less crowded market conditions.
P&I: How does ORIX USA best position itself to take advantage of opportunities?
Bede: Access to capital as well as experience are crucial, as growth companies put a premium on sophisticated lenders that they can trust and that can grow with them over time, and we have been doing this for a long time. Being able to upsize our loans to support our borrowers’ growth trajectory is a key competitive advantage. ORIX USA uniquely uses its balance sheet to invest alongside our third-party client capital.
The lion’s share of our origination is proprietary, either via the venture and private equity sponsors or directly with the company. In this space, it really helps to have a proven market presence and ongoing origination channels. Having been in the market for 22 years, we have developed extensive relationships, strong references, and a long track record in growth industries.
Growth lending is a more intangible and dynamic market than more traditional lending sectors. The current tech market downturn has been a more enduring decline, with businesses needing to sustain through several years of tougher external market conditions. That puts a premium on strong underwriting ability and experienced portfolio management with teams like ours who have the knowledge and confidence to lean in with both new and existing investments.
P&I: Which sectors within technology present opportunity, even with the broader market still experiencing this downturn?
Bede: We see an opportunity set of software and technology-enabled businesses across sectors that have common attractive attributes: differentiated products, revenue scale, attractive customer retention rates, customer diversification, continued growth, high gross margins, and manageable cash burn.
Our team also continues to focus on the traditional enterprise SaaS, or software-as-a-service, market. We feel these businesses are a good fit for debt because of embedded products with high revenue visibility and contracted recurring revenues that tend to be sticky and produce high margins. Given the impact SaaS continues to have across industries, it is a key theme that hasn’t fully played out, especially on the debt side. Acquisition and buyout capital also drives demand for growth debt, and a good portion of the many venture businesses funded in the early 2020s will soon need a home.
In addition, artificial intelligence (AI) is attracting the lion’s share of new equity capital. We’re going through a systemic change, where new businesses are being created and almost every business will need to figure out how to incorporate AI into their products and services, creating a need for new capital and growth debt will play a valuable role.
P&I: How do you identify the right kind of companies in today’s macro environment, where many growth companies have struggled with slower growth, less capital availability and high rates?
Bede: Venture/growth equity and debt can have differing investment lenses, but growth continues to be critical to both. With all the macro headwinds, companies that have been able to continue to grow through the current environment can be very attractive from a credit point of view. That said, debt doesn’t necessarily need a high value exit to drive attractive risk adjusted returns, and so it does not require the same growth rates that equity does. Another important dynamic for lenders is efficient growth, meaning companies that grow with manageable operating cash burn. We look for companies to be well funded with long liquidity runways so that medium-term capital markets challenges around equity and M&A are unlikely to come into play, even if the company underperforms.
We lend to what we consider premium companies, but we also see a current market opportunity in funding those attractive, growing businesses that may not be able to deliver the high exit valuations new equity investors would expect. They have important uses for the capital that outweigh the cost of the debt such as driving continued sales and marketing and strategic R&D investments.
Additionally, our senior secured loans possess strong structural protections including at least one, and typically multiple, financial covenants. As prudent lenders, we are experienced in managing downside scenarios when needed.
The “rule of 40” has received a lot of attention in venture equity — the growth rate plus profit margin should be at or above 40% to receive equity investment. On the debt side, I’m going to coin the term “rule of 20.” With all the credit strengths of our businesses — strong product differentiation, recurring revenues, low debt to value, etc. — we believe a 20% growth that’s breakeven or a 30% growth with -10% profit margins is just fine. There is a much broader range of companies that meet this, especially in today’s market. Growth lending returns are more structured with a coupon, fees and equity kickers.