The economic recession is not only having an impact on the ability of startup companies to raise venture capital financing, but also their desire to take on venture debt. A few years ago, many of the venture capital deals completed in the Seattle area included some form of debt financing.

But that's changed in the past year, according to industry watchers.

"There's tremendous pendulum swings in the moods of VCs, entrepreneurs and venture banks for taking on debt in an early-stage company," said Craig Sherman, an attorney with Wilson Sonsini Goodrich & Rosati. "And I think the reason is, whenever the market turned south, everyone involved realized that a venture loan from a traditional venture lender does not extend your (cash) runway at all."

The reason is that boards will require that a loan from one of the traditional venture lenders -- Silicon Valley Bank, Comerica Bank and Square 1 Bank -- be paid back before the company implodes.

"The (VCs) don't want to damage the relationship with the bank because they have so many other existing portfolio companies doing business with the bank and they want to continue to work with the bank going forward," said Sherman, who has worked with startup companies in Seattle for more than a decade.

Craig Sherman

Two years ago, Sherman said that venture debt accompanied about half of the startup financing rounds that he worked on. Now, he said they are seeing far fewer unsecured loans for startup companies -- in part because the terms on the loans are more stringent.

In some cases, covenants are placed on the deals, making them a less interesting financial instrument for startup companies.  

Nonetheless, bankers that specialize in lending to small startup companies say they continue to do deals.

"This type of credit remains readily available in this environment," said Bruce Helberg, Northwest Market Manager at Silicon Valley Bank. "We have closed a number of early stage venture debt deals the last few months."

Helberg points out that startup companies are more dependent on angel investors and venture capitalists for their capital needs, so they don't typically rely as much on leverage.

Still, the tight credit market has had an impact on the capital outlays from venture debt funds to startup companies, said J.P. Michael, senior vice president and regional managing director at Comerica.

Some of the venture debt funds that Comerica used to partner with on deals just aren't making the rounds these days in Seattle, with Michael saying the last joint deal he did with another firm was about 18 months ago. 

"We have seen less financings in Seattle and in the Northwest, therefore there are less deals for us to do," said Michael. "But we haven't pulled back from the market at all, and we are still looking for opportunities."

Still, there simply isn't as much capital flowing either from venture capitalists or the venture banks that provide the debt financing.

"Two years ago, it was always raise $10 million and go out and raise the biggest venture debt deal that you can and put it on the books. People who raised $10 million might have had $3, $4 or $5 million in venture debt," he said. "Now, you are not seeing as big of rounds or not as many."

And with the weak economy continuing to take a toll on big and small companies alike, Michael said they want to make sure the companies that they bank hit their milestones and have the ongoing support of venture capitalists. That means stricter terms on the money they allocate.

And that's not necessarily a bad thing. During the dot-com meltdown, Sherman said that some of the venture banks got caught when companies couldn't repay their loans.

But Sherman is not seeing as much of that this time around, in part because people learned lessons from 1999 and 2000.

"The banks were far more conservative going into this downturn," he said.

Follow John Cook on Twitter @johnhcook.

[Flickr photo via Sylvar]