Month: May 2013

Venture Debt 101 – Banks vs. Venture Debt Firms

 Venture Debt 101 – Part II (I had originally though of just writing a 2-parter, but think a multi-parter is needed, with the next post being the anatomy of a Venture Debt term sheet).   Banks vs. Venture Debt Providers:  In part I of my Venture Debt 101 series, I outlined the basics of Venture Debt financing for start-ups.   It’s fairly straightforward and provides a very high level roadmap of navigating if and when a Company should consider Venture Debt financing. A topic that garners significant confusion is how to choose a partner when signing up for Venture Debt.   There’s certainly no shortage of institutions that provide Venture Debt financing, but who you choose may be critical in ensuring long-term financial viability for your company. I’m going to again reinforce a point from my last post: Think long and hard about who you’re taking debt from and what type of provider you’re using.  Cash can be different shades of green, so use the same level of diligence you used with your equity sponsors as you would with your venture debt provider. Fundamentally, there are 2 forms of Venture Debt Providers – Banks and Venture Debt Firms. Banks:  Everyone of course knows what a Bank is.  Banks that offer Venture debt source capital from client deposits and offer Venture Debt as part of an overall debt/banking solution.   Banks most active in the Venture Debt space include organizations such as Silicon Valley Bank, Comerica, City National (fairly new entrant) and, Square 1 Bank (I’m defining Venture Debt here as term loans designed to help pre-profit early to growth companies extend cash runways.  As such, I’m not including traditional middle-market lenders that provide late stage covenanted term loans or working capital financing).   Other banks such as Wells Fargo may also provide Venture Debt on a discretionary basis. Venture Debt Firms:  Venture Debt firms, which first started forming nearly 30 years ago, are firms that primarily operate as closed ended funds with capital coming from 3rd party Limited Partners (and in certain cases public capital).  The Venture debt firm universe is fairly large and fragmented with many smaller niche players surfacing over the past 10 years.  Some of the larger and more notable names include Western Technology Investment (WTI), Triplepoint Capital, Hercules Technology, Lighthouse Capital, Pinnacle Ventures, Horizon Ventures, Pivotal Capital, Structural Capital, Orix Capital, and Escalate Partners. Pivotal and Structural are newer Venture Debt firms (although are led by tenured venture debt professionals).  To be able to understand the difference between the 2, it’s important to understand the risk/return profiles of each.  The table below provides an illustration of this – I’ve added in Venture Capital Equity financing as a measure...

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Venture debt 101

(Note: This will be a 2 Multi-part blog, with the next post focused on comparing and contrasting Venture debt from Venture Debt firms vs. Banks).  For the uninitiated, Venture debt is simply debt financing for Venture Capital backed companies for the purpose of accelerating growth in a way that’s minimally dilutive for shareholders. While there are several forms of debt available to start-ups (Asset Based Accounts receivable, Equipment, Recurring Revenue), Venture debt in the purest sense is non-formula based term financing with durations of 3-5 years. On a typical week I speak to 3-4 entrepreneurs a week regarding the relative pros and cons of taking on Venture Debt.  As such, I thought I’d put together a quick synopsis about the topic. When is it appropriate for a Company to explore Venture Debt? ▪   The company is backed by a strong syndicate of Venture partners that has the ability to further support the Company financially with or without the introduction of a new lead. ▪   For early stage companies, the management team should be able to clearly define the milestones prior to the next equity fundraising, and should have a high degree of confidence of reasonably hitting them.  In addition to the aforementioned, later stage companies will need sustained revenue traction and have some customer diversity. ▪   The Company has a management team that preferably has worked with secured creditors in the past (not necessary of course!). What type of situations do Lenders often find challenging in providing Venture Debt? ▪   No backing from Venture Capital firms. ▪   Companies that are just entering commercialization with marginal visibility into timing and significance of near term sales opportunities. ▪   Companies that have recently restarted or have recently gone through a significant business model reorganization. ▪   Companies that have incomplete executive management teams (i.e. searching for a CEO). ▪   Companies that have raised significant amounts of equity capital with very little progress. ▪   Companies that are completely reliant on bringing in an external investor or a liquidity event for repayment of loan. What are some of the benefits of Venture Debt? ▪   Used appropriately, venture debt can provide incremental runway between equity rounds for early stage companies, allowing for additional time to meet critical milestones. ▪   For later stage companies, and in conjunction with a working capital line, Venture debt can alleviate and smooth out liquidity needs. ▪   Results in nominal dilution to shareholders and can greatly impact shareholder returns. What are the risks of taking on Venture Debt? ▪  Overleveraging is common and can impact fundraising efforts if Company is not performing well. – Venture debt should not be more than 50% of last institutional raise and...

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