The venture debt market is facing a looming crisis as startups struggle to stay afloat, with lenders increasingly pushing for acquisitions to minimize potential losses. The recent shutdown of accounting startup Bench and the financial challenges faced by digital freight company Convoy are just a few examples of the struggles many startups are facing. According to David Spreng, founder and CEO of venture debt provider Runway Growth Capital, "We're getting to the end of the rope for a lot of companies."

The root of the problem lies in the lax diligence of venture capital firms in 2020 and 2021, which led to the funding of many weak startups. As a result, many of these startups have already failed, and data suggests that many more will follow suit in 2025. Venture debt, which reached a record $41 billion across 2,339 deals in 2021, according to Silicon Valley Bank, will play a significant role in the crisis.

Divvy Homes, which was sold to Brookfield Properties for around $1 billion, is a prime example of the challenges faced by startups. Despite the significant sale price, some shareholders were left without any payout, highlighting the risks associated with venture debt. The company had borrowed $735 million from lenders, including Barclays, Goldman Sachs, and Cross River Bank, in 2021.

According to John Markell, a managing partner at venture debt advisory firm Armentum Partners, nearly every lender has troubled companies in their portfolio, and many are pushing startups to sell themselves to minimize potential losses. This can result in forced fire sales, where companies are sold for a fraction of their previous value, or foreclosure, where lenders claim underlying assets to recover their investment.

Startups can avoid this fate by convincing new or existing venture capital firms to inject more cash by buying more equity. However, investors are increasingly reluctant to fund startups that are growing too slowly to justify their sky-high valuations achieved in 2020 and 2021. As a result, many startups will have no choice but to sell for a low price or shut down this year.

In situations where lenders are forcing an acquisition, equity investors are generally not getting much of the money being paid, and often not even making their money back. This is a risk that venture capitalists are aware of, but it doesn't change the fact that many startups are facing an uncertain future.

Despite the risks associated with venture debt, it remains a popular option for startups. In 2024, new venture debt issuance reached a 10-year high of $53.3 billion, according to PitchBook data. A significant portion of this capital was directed towards AI companies, with notable examples including CoreWeave, which secured $7.5 billion in debt financing, and OpenAI, which obtained a $4 billion line of credit.

The venture debt crisis highlights the importance of due diligence and responsible lending practices. As the startup ecosystem continues to evolve, it's clear that lenders and investors must adapt to the changing landscape to avoid a repeat of the crisis.

In the meantime, startups must be prepared to face the challenges ahead, and lenders must be willing to take a hit to minimize their losses. As Spreng notes, many startups will have no choice but to sell for a low price or shut down this year. The question is, how many will be able to avoid this fate and emerge stronger on the other side?