Venture Loans: Babson MBAs Learn About Venture Debt Financing
Recently, several students from Babson College’s MBA program called requesting an interview. They were researching the venture debt market and wanted an inside look at how this segment compares to venture capital. Your questions were thoughtful and I thought it was worth sharing the discussion. An excerpt from the interview appears below:
Q. How are Venture Loans (VL) different from Venture Capital (VC) when it comes to fundraising expenses?
A. Fundraising expenses associated with venture loans are generally lower than those of venture capital transactions. Legal fees are one of the largest expenses in many transactions. Lenders often negotiate subprime loan agreements using their standard documents. Venture capitalists, however, often use newly created stock purchase agreements. These agreements add considerable expense to these transactions since outside legal advice is used. Other VC expenses include a more expensive and comprehensive due diligence process.
Q. What about the flexibility of the terms of the agreement?
A. It is difficult to compare the flexibility of terms between the two forms of financing. Flexibility can vary from lender to lender and from VC to VC. In general, venture capital is a more flexible form of financing than venture debt, as the proceeds are allowed to be used for many purposes. Collateral is generally not required and there are fewer agreement agreements than lenders require. Venture loans often limit the use of proceeds to purchased capital assets or for specific working capital purposes. Venture lenders generally require collateral and may incorporate various covenants and conditions into their loan agreements.
Q. Are there any VL companies that focus on segments other than technology or life sciences (eg, retail, restaurants)?
A. Currently, there are not many venture lenders that specialize outside of those areas. The universe of venture lenders is relatively small, particularly compared to the venture capital industry. There are probably less than thirty American companies that specialize primarily in venture loans or leasing. Most are involved in the segments you mentioned.
Q. How long does it normally take to get money from a venture lender? How many visits does an entrepreneur have to make to a venture lender before making a final decision?
A. Most venture loans take at least thirty days to complete from the time the prospect is met to the actual funding. The completion time can vary up to sixty days or more, depending on the complexity of the credit. Most lenders will meet with the prospect several times before committing.
Q. Can an entrepreneur continue window shopping if a venture lender has initiated due diligence?
A. Yes, but lenders disapprove of purchases due to the length of time they commit to processing the transaction. The norm in the business is to link a transaction with a letter of commitment and a fee. If the borrower/lessor continues to shop and chooses another provider, he or she generally forfeits the fee.
Q. Ideally, at what stage would an entrepreneurial business be considered safe for venture lending (for example, a start-up looking for first round financing or a business that already has first round capital and is looking for second round financing?) )?
A. Most venture lenders get involved after the company has successfully raised at least $5 million or more from a reputable venture capital sponsor, i.e. after Round A.
Q. What are the collateral requirements for a “growth capital” loan?
A. Warranty requirements vary. Some risk loans/leases are specific guarantees. The lender requires collateral in the form of the equipment being financed. Other transactions are more flexible, allowing proceeds to be used for general growth and working capital purposes. In the latter arrangements, lenders may require an all-asset (‘general’) lien on the borrower’s assets.
Q. Would venture lenders invest in a company not sponsored by venture capitalists? Are there any exceptions?
A. Venture lenders typically invest only in companies backed by venture capitalists or accredited investors with future capital to commit. The reason these sponsors are needed is that the company is generally not nearing the point of profitability and will require additional funding rounds. There are exceptions and it depends on other credit strengths. For example, a particularly strong cash position and strong collateral may entice a lender to relax the requirement for ongoing venture capital support as long as the lender has confidence in the management team. Other factors may also influence the decision.
Q. What are the top four or five features you consider before deciding to fund a startup?
A. We are looking for talented and experienced senior managers, strong VC sponsorship from reputable VCs, a compelling business plan and business history from inception, acceptable cash position and burn rate, and acceptable collateral quality.
Babson MBA: Mr. Parker, thank you so much for taking the time to talk to us about venture loans. His talk has given us the opportunity to gain valuable insight into this exciting industry.
George Parker: It’s been a pleasure. I hope you find this information helpful and that you consider venture loans as you form your career plans. Good luck in your research and give me a call if you need more information.
