With VC funding down 83% since historic 2021 levels, emerging companies look to new sources such as banks and credit funds to extend runway.

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If entrepreneurship is the engine of innovation, liquidity is the fuel. Funding provides companies with essential capital for product development, market research, and operational improvements. However, as venture capital (VC) funding has decreased 83% from its peak in 2022, emerging companies are increasingly expanding their sources of capital, exploring new avenues to keep operations moving forward. Debt financing from banks or non-bank lenders has emerged as a popular, non-dilutive option, allowing founders more time to grow their business and retain talent without giving up equity.

As bankers working with the innovation economy, we see firsthand what lenders prioritize in startups seeking funding. Based on our experiences, here are five essential considerations that lenders evaluate when making funding decisions:

1. Commercial Viability

Lenders seek startups with a "protective moat"—a solid foundation built on proprietary technology or unique services that are difficult to replicate. While positive cash flow is critical, lenders recognize that cash-burning companies may still be viable if they demonstrate a clear path to profitability. Lenders focus on revenue durability and predictability, as recurring revenue gives them confidence in future cash flow even if short-term cash burn exists.

2. Supportable Valuation

While investors and lenders both pay attention to valuation, they do so for different reasons. A higher valuation, compared with the amount borrowed, provides a cushion for loans reliant on enterprise value for repayment. Established businesses with demonstrated revenue streams or a history of high valuations, often achieved through recurring revenue or prior fundraising, are favored. A lower debt-to-enterprise value ratio can reduce lender risk, as it indicates a lower chance of loss.

3. Investor Support

Startups backed by reputable tech investors stand out. Lenders look for indications that a company has the ongoing support of well-established investors with "dry powder" capacity, or sufficient reserves, to provide future capital if needed. Lenders often have a bias toward investors who have a track record of supporting portfolio companies, ensuring that the startup has access to additional capital even in challenging times.

4. Financial Controls

Strong internal financial management and reporting are pivotal. Startups with reliable financial controls and the ability to respond promptly to diligence requests demonstrate an understanding of their own business operations. While lenders may rely on reports created for boards or investors, the ability to address specific information requests quickly and accurately can positively impact the borrowing process. Additionally, startups with effective revenue management, controlled expenses, and strategic investment practices demonstrate desirable financial management qualities.

5. Clear Vision for Addressable Market

Lenders want to fund startups with a clear understanding of their target market and growth potential. Companies should be able to articulate an identified need for their product or service and demonstrate room for growth by replacing existing technologies or expanding market share. Realistic assessments of the Total Addressable Market (TAM) and potential sales growth provide confidence that the company’s projections are achievable.

Hopefully, these insights help demystify the bank lending process and clarify some of the factors that contribute to a successful borrowing experience. In the right circumstances, banks can be a reliable option for founders seeking additional runway to achieve their growth goals.

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By Dzung Nguyen, East Coast Market Executive, and Gaston Burthey, Senior Vice President & Senior Lead Relationship Manager, Mid-Atlantic and Southeast. The views expressed here represent the opinions of the author on prospective trends in middle market banking and do not necessarily reflect those of Wells Fargo & Co. All credit decisions are subject to credit approval.