Taking out debt used to be a mark of shame in the startup world. Investors like Peter Thiel are helping make it cool.

• Peter Thiel poured $250 million into Tacora Capital, which reflects a new interest in venture debt.
• Startups that might've raised cash now look to debt, bucking the stigma around taking on loans.

When startups need money, there's a pretty common game plan to follow: Sell shares off to outside investors, swapping equity in the company for the cash they need to grow. But what happens as the market sours and those investors stop writing so many checks?

Investors like Peter Thiel, the famed PayPal cofounder and former Facebook board member, think they have an answer: debt. Unlike the traditional venture-capital model, venture debt lets startups limit outside control — at the cost of having to pay the principal and interest on the loan back, usually over a term of three years.

Data from the startup tracker PitchBook showed that US venture debt reached $26.5 billion in value at the end of November. This represents 1,925 deals between startups and venture-debt providers. The second quarter of 2022 became the second-largest quarter in debt value in the past 10 years, that data showed.

For Thiel's part, Bloomberg reported he invested in Tacora Capital, a venture-debt fund, in December, which made him the latest and highest-profile mainstream investor to bet on that corner of the industry.

For a long time, the conventional wisdom in the tech-startup scene has been that taking on debt is a sign of a weak business that can't raise money from traditional investors. Moves like Thiel's are a sign that things are changing.

Some industry insiders are going so far as to say that venture debt can make for a better, more resilient business — there's nothing quite like owing a massive loan to keep a startup focused on low costs and building a good business model.

"There's going to be a new crop of founders in 2023 and beyond that are saying to themselves, 'Maybe raising a ton of venture and going for growth at all costs is not a good idea,'" Billy Libby, a managing partner and the CEO at the venture-debt and venture-capital firm Upper90, said. "Founders want to start a profitable business while thinking about their ownership, balance sheets, and sustainable growth."

Out of the shadows

Despite the stigma against debt in the startup community, it's long been a key weapon in the financial arsenal among larger companies. Taking out debt gives a speedy way for those companies to invest in their own growth, while serving as a signal of its confidence that it can pay the money back.

Even among startups, 70% of all venture debt is held by later-stage companies, per PitchBook, which gives them a way to raise money without diluting their investors or giving up more board seats. PitchBook's data shows earlier-stage companies are accounting for larger amounts of total debt raised.

Startups can access venture debt through banks like Silicon Valley Bank or funds that specialize in the vehicle. Since those lenders deal with younger companies, venture-debt terms can be more flexible than traditional business loans.

Debt does have its drawbacks, naturally. Paying back a loan with interest can be a challenge for the largest of companies; for smaller startups experiencing the ups and downs of the early business cycle, it can be a huge burden. And when the startup either goes public or goes out of business, the debt lenders get first dibs before outside investors.

Libby of Upper90 said that for the right small startup, however, debt could give it the tools and discipline to succeed. He suggested that startups with fixed costs and revenues were best-suited for the debt vehicle: He used the real-world example of a startup his firm works with that did good, steady business selling salmon directly to consumers.

Traditional VC isn't going anywhere

What the experts all agree on is that venture debt isn't going to replace the traditional venture-capital model anytime soon.

Debt can complement more traditional equity fundraises, a report from Silicon Valley Bank said. In fact, the bank suggests that having a traditional venture-capital firm (or several) on board as an investor can help make it easier for a startup to qualify for a loan.

It's also worth noting the rise of alternative financing, which has grown in popularity in the past year. Companies like Capchase, Clearco, and Pipe offer credit lines to startups, particularly software companies, typically with a shorter term than venture-debt providers allow.

Ultimately, what it all comes down to is that venture debt is no longer in the shadows — especially as it gets harder to raise money the traditional way.

"We're going to see more companies go for debt next year because it's more relevant now," Libby said.