Growth lending’s role in the venture ecosystem

Episode notes

In episode two of our InvestorExchange private credit series, Jeff Chapman, head of growth lending, outlines the growth lending market, how and why it has evolved, and much more.

Key topics:

1:55 – Jeff’s background in growth lending

4:00 – Growth lending market overview

5:00 – Lending to cash-burning companies

6:15 – What types of companies access growth lending?

7:00 – How has the growth lending market evolved?

9:10 – Underwriting, covenants, sourcing

10:30 – Growth lending amid a decline in venture fundraising

13:30 – Why a company would partner with Wellington

14:30 – Jeff Chapman, photographer 

Transcript

Jeff Chapman: I think that the main thing to think about is that both management teams and investors on the equity side have just become accustomed to using credit. It is now a part of the ecosystem. So that's $60 billion, just by way of reference on that, the total equity invested was about $200 billion. So roughly a third of the amount of equity invested. So this is a major piece of the venture ecosystem now.

Sonali Wilson: Hello and welcome to episode two of our private credit Wellington Investor Exchange. This three part mini series explores the evolution and expansion of private credit markets from a niche post GFC solution to a dynamic $40 trillion ecosystem, featuring insights from veteran OG portfolio managers who helped shaped their respective area of expertise. Today we're digging into growth lending, experiencing a surge in relevance and opportunity post the collapse of Silicon Valley Bank. This market has grown in issuance 90% year over year, driven by startups desire for non dilutive capital and the rising cost of equity in today's environment. It offers investors access to high growth sectors like technology, AI, life sciences, healthcare, fintech and climate tech, while giving founders flexibility, speed and control to scale without sacrificing ownership. I'm your host, Sonali Wilson, I'm the platform leader for private credit at Wellington. I'm joined by Jeff Chapman, head of growth lending. Jeff leads the firm's private lending investments to high growth venture backed companies, and I can't think of anyone better to discuss this evolving market than the 20 plus year pioneer in growth lending. Welcome, Jeff.

Jeff Chapman: Hello. Happy to be here.

Sonali Wilson: So, Jeff, before we dive into growth lending, I would love to just hear a little bit about how a young boy raised in Tucson, Arizona, ends up in Silicon Valley.

Jeff Chapman: Okay. Well, I was born in San Jose, actually, in Silicon Valley, but then my dad, worked for IBM, and he was asked to head up a new plant in Tucson, Arizona, in 1980. So he moved his California family out to Tucson, where I grew up. Both my parents went to UCLA. So that was one of three places that I was allowed to apply to college when I was in high school. Fortunately, I got in, I went to UCLA, and then I decided, after UCLA, I had a microbiology degree and I wanted to go get a PhD somewhere. And UCSF had a fantastic program, and I applied to get a PhD in immunology. And started up the next year. So I moved to Silicon Valley to really study science. As luck would have it, I did not like doing science nearly as much as I liked studying science. I spent my days, unfortunately, euthanizing mice. And that just wasn't something that I thought of doing long term. So I wanted to somehow remain in science, but I thought maybe, taking an investment approach would be more interesting. A fellow classmate of mine actually decided to start a company. So I left a grad program, and I helped start this company, became venture backed. And, we did that in December of 1999. Which was terrible timing. We got a few months of the dotcom bubble and then many, many months of the dotcom bust afterwards. But that was a great first experience for me to understand what it's like to, to run a venture backed company. After that, I went off to business school and then ultimately got into growth lending in 2007. And I've been doing it ever since. I've worked at both banks and funds. I've worked on over 50 deals. Then Wellington management reached out, and I really thought this opportunity was just too good to pass up.

Sonali Wilson: Well, I'm glad you're no longer euthanizing mice and have instead graced us as an investor in growth lending. A lot of our listeners know private credit as middle market direct lending, and you've referenced growth lending a few times. What is it and how does it work?

Jeff Chapman: Sure. So fundamentally, growth lending is just lending against the enterprise value of a business rather than its cash flows like you would in more traditional middle market lending. These companies are typically venture capital backed or growth equity backed. So they're focused more on growth than they are on profitability. So most of them are still burning cash. The asset has been around since the late 90s, and it's grown pretty much year over year, every year since, into 2024, which was a record year of loan issuance at $60 billion. Boards and companies, are open to taking credit in this space because for the ones that we want to lend to, which are late in growth stage, they've already raised many rounds of equity and they're close to an exit, and they're very dilution sensitive. So if they can have a credit option rather than raising more dilutive equity, that's very attractive to them.

Sonali Wilson: Sounds like you're lending to companies that aren't profitable. So I would assume cash burning. So my next question is just how do you lend to a cash burning company without losing money?

Jeff Chapman: Sure. So it does sound hard, but, it turns out that it is actually not nearly as risky as it might sound. So what we do is we focus on late and growth stage companies that have raised many rounds of equity. So these aren't early stage series A or series B or seed companies that might have a very young management team and not much commercial traction. These are companies with significant growth, significant revenue and very experienced management teams. So that's number one. As second, we take a senior secured position on these loans. So we're ahead of all that equity in the cap stack. And then we lend a much lower loan to value (LTV) than one would in middle market lending. Middle market it might be 40 or 50 or 60%. And growth lending it's 25% or less. So smaller loans relative to the company. We also use covenants. So these aren't cove-lite loans. Covenants might be a growth covenant or a liquidity covenant or both or other covenants. On top of that as well. And then the last thing is a full credit underwrite on these businesses. 

Sonali Wilson: That sounds like for a lot of these companies, you do a fair amount of work in how you structure the deal, how you underwrite them. So how do you think about what types of companies are best suited to take on your type of financing?

Jeff Chapman: Sure. We look for very similar things to what folks on the equity side do. So we are looking for consistent high growth. We're looking for strong unit economics. We're looking for pricing power in whatever industry they happen to be in. We are looking for seasoned management teams. We do want or we would prefer institutional backers, you know, large pockets around the table are great. And then because we're looking at latent growth stage companies, we also are looking for a clear path to profitability for these companies as well. We may come in as last money. We may come in is last money alongside an equity round that's actually quite frequent. There might be 1 or 2 equity rounds in the future, but that's something that we would spend a lot of time on.

Sonali Wilson: And Jeff, maybe who's lending to these companies? You're a private player in the market. Are there other types of lenders lending to these companies?

Jeff Chapman: There are, so of course, everybody's heard of Silicon Valley Bank. There are commercial banks in this space. In fact, SVB is still lending in this space. Since 2023, there have been new banks with former SVB employees, start up and become active in this space. There are BDCs that just focus on venture backed companies as.

Sonali Wilson: Those are business development companies.

Jeff Chapman: Correct. And there are private credit funds and large global investors as well.

Sonali Wilson: And, I guess, you've been doing this for 20 plus years, and how have the players in that space evolved and sort of who's winning business today?

Jeff Chapman: Initially, when I started in this industry in 2007, I joined a small fund and it was just a handful of folks doing this. I think at the time, 2 or 3 plus Silicon Valley Bank. It's grown pretty significantly since then, into a much more robust universe. I would say competitively, the BDCs are active, they're very well known at this point. Smaller private credit funds, I think have a niche focus. So you may run into them here or there. We are also running into much larger groups than you would historically expect, some of which are very active in middle market and sometimes may try to dip down into this space if they can. And others who are recognizing an opportunity here and just getting in.

Sonali Wilson: Jeff, you hit briefly on the fact that these deal sizes are growing. What's that a function of?

Jeff Chapman: So right now in venture overall companies are staying private for longer. In fact, just over the past couple of years, the time to IPO is extended from five and a half years to seven and a half years. And what that means is that there are more private companies, and those companies are scaling more as private companies now than they ever have. So a lot of the value accretion is happening pre-IPO. Loans scale with company scale. So these loans are getting bigger to match the company's size. And the sheer number of companies just creates a large amount of demand for capital.

Sonali Wilson: And you alluded to this a little bit earlier in your in your comments on the importance of underwriting and having covenants as these loans scale in particular. Can you maybe talk a little bit about what the structure of the loan in this space would look like?

Jeff Chapman: So these loans are typically 4 or 5 year loans. They will typically have an interest only period of 12 or 24, 36 months, something like that. There are typically fees up front and on the back end. And, they do come with warrants as well. So as a lender, there is the potential to get upside convexity if that company that you're lending to has a nice exit down the road at a share price higher than the one when you got involved. The covenants come as a function of trying to protect that growth and liquidity in these companies primarily. So it's not uncommon to have something as simple as a revenue covenant. And something as simple as a cash floor, a cash balance minimum.

Sonali Wilson: So sounds like you do a lot of work when it comes to underwriting these deals and structuring them. Talk to me a little bit about originating the deals. Where do you source deals from?

Jeff Chapman: So this is a very unique space, for sourcing. These are very small companies, relatively and even smaller venture funds. So you really do have to build up a network over time to even see these deals. So as a new firm in this space, you can't just parachute in and expect to win deals. You probably wouldn't even find any deals. 

Sonali Wilson: If we take a big step back, venture fundraising is down. So what does that mean for you as a lender?

Jeff Chapman: Sure. Well, I guess if we think about, let's say, the last five years or so in venture, if you go back to 2020, especially 2021, what's happening? So a record amount of equity is getting raised, a record number of deals are getting done and a record number of companies are formed. So there's now over 60,000 venture backed companies. And by way of reference, there's about 4500 US public companies. There's maybe 12 or 13,000 private equity backed companies. So 60,000 is a huge number of companies. That creates a huge amount of demand for capital. Most of these companies are burning cash. They need more equity. But what happens next? Well, in 2022, we see a spike in inflation. We see a subsequent increase in interest rates and then a depression in exits. So both IPO and M&A. And also in fundraising like you alluded to. So fundraising actually peaked the next year in 2022. But then really dropped, I wouldn't say off a cliff, but it's definitely suppressed from where it was before. So we have this huge amount of demand for capital, but we have much less supply, both supply from the public markets and also supply from the private markets. So since then, I would say the deal pace has improved, but this supply to demand imbalance still exists. So right now there's between 2 and 3 times more demand than supply of capital in both the late and growth stage venture. Well, so what does that mean for credit? None of this is lost on lenders. So if we look back to 2021 that was actually at the time a record year for lending. It was $40 billion, which was a huge number. There was a little bit less done in 2022 and then 2023 what happens? Well Silicon Valley bank collapses. So there's a 28% drop in 2023. Other lenders also took a couple of months to make sure the dust was actually settling. But then in 2024, what really happened is they stepped in in a large way to meet this huge amount of demand that exists. And so last year was a $60 billion a year, which was a massive increase from 2023 and 2025 kept up that pace to fewer companies. So these loans are actually getting more concentrated and larger at the exact same pace. So what do we expect from here. We expect more of the same on the credit side. So there hasn't been much of a change on the venture fundraising side. We'll see with IPOs there could be some green shoots there. But I think that the main thing to think about is that both management teams and investors on the equity side have just become accustomed to using credit and is now a part of the ecosystem. So that's $60 billion. Just by way of reference on that, the total equity invested was about $200 billion. So roughly a third of the amount of equity invested. So this is a major piece of the venture ecosystem now.

Sonali Wilson: Jeff, given that deal sizes are up, issuance volumes are up. Yet you alluded earlier in the conversation to this being like a relatively closed ecosystem. Why would a company want to partner with Wellington over some of the more entrenched lenders in this space?

Jeff Chapman: Sure. Well, first of all, the reputation that Wellington has as a large, very highly regarded global firm is definitely a draw. Both companies and boards want to work with a solid counterparty. But I think probably the primary reason that companies and boards would be interested is it's not lost on them that Wellington does have these other capital pools that they might be able to tap into at some point. So the fact that they could potentially raise from our late stage growth team or one of our public investors might decide they think there should be a public company and help take them public, and/or come in at scale once they are a public company, you know, for a relatively small company who is cash burning, this is a fantastic outcome if they can get under this Wellington umbrella.

Sonali Wilson: Jeff, I want to end maybe on a more of a personal note, as you've talked about your career as a growth lender, clearly you've had to have a keen eye and be able to see things that maybe others can't always see. And I do know that one of your largest hobbies is to be a photographer. Can you tell me how that came about?

Jeff Chapman: I grew up in a household, where my father was a photographer. He literally built a dark room into our home in Tucson. And so it was always around me. And then, my sister ended up getting an MFA in photography. I was always interested. I thought it was a fun way to combine creativity and also technical components. When I became a dad, it's a great hobby to have when you've got little kids running around. My little kids are now big kids. They're both in high school. They're both athletes. And so my interest has become doing sports photography. So I do sports photography for their high school, for my son's soccer club and a variety of other things.

Sonali Wilson: Photography is a great place to end our conversation today. Similar to growth lending, it's a blend of the creative and technical. Thank you for walking us through this exciting, growing part of the private credit market. Once again, this is Jeff Chapman, head of growth lending at Wellington. Thanks so much for joining us.

Jeff Chapman: Thank you for having me. It's been wonderful, Sonali.

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