Recently, several students from the Babson College MBA program called to request a talk. They researched the venture debt market and wanted an insider’s view of how this segment compares to venture capital. Their questions were thought-provoking and I thought the discussion was worth sharing. An excerpt from the interview is shown below:
Question: How does venture capital (VL) differ from venture capital (VC) when it comes to collection costs?
A. Fundraising expenses for venture loans are generally lower than for venture capital transactions. Attorney fees are one of the biggest expenses in many transactions. Lenders typically negotiate venture loan schemes using their standard documents. However, venture capitalists usually use newly created stock purchase agreements. These agreements add significant expense to these transactions as external legal counsel is used. Other VC expenses include a more expensive and comprehensive due diligence process.
Question: What about the flexibility of the terms of the agreement?
A. It is difficult to compare the flexibility of the conditions between the two forms of financing. Flexibility can vary from lender to lender and from VC to VC. Generally, venture capital is a more flexible form of financing than venture debt, as proceeds must be used for many purposes. Usually, no collateral is required and there are fewer contract agreements than lenders require. Venture loans often limit the use of proceeds to the acquired capital assets or to specific working capital purposes. Venturers usually require security, and they can incorporate multiple covenants and conditions into their loan agreements.
Question: Are there VL companies that focus on segments other than technology or life sciences (e.g. retail, restaurants)?
A. There are not many venturers that specialize outside these areas at the moment. Venture lenders are relatively small, especially when compared to the VC industry. There are probably fewer than thirty U.S. companies that mainly specialize in venture loans or leasing. Most are involved in the segments that you mentioned.
Question: How long does it usually take to get money from a venture sponsor? How many visits should an entrepreneur have to a venturer before a final decision is made?
A. Most venture loans take at least thirty days to complete from the time you meet the prospect of actual financing. The closing time can vary up to sixty days or more, depending on the complexity of the credit. Most lenders will meet with the prospect a couple of times before committing.
Question: Can an entrepreneur continue to window-shop if a venture lender has started due diligence?
A. Yes, but lenders frown upon shopping because of the time they commit to processing the transaction. The norm in the business is to bind a transaction with a commitment letter and fee. If the borrower / tenant continues to act and chooses another provider, the fee is usually forfeited.
Question: At what stage would an entrepreneurial venture be considered secure with venture lending (e.g., a startup seeking the first round of funding or a company already having a first round of capital and seeking a second round)?
A. Most venturers are involved when the company has successfully collected at least $ 5 million or more from a reputable venture sponsor – that is, after the A round.
Sp. What are the collateral requirements for a “growth capital” loan?
A. Security requirements vary. Some venture loans / leases are security specific. The lender requires security in the form of the equipment being financed. Other transactions are more flexible, allowing revenue to be used for general growth purposes and working capital. In the latter schemes, lenders may require a mortgage on all of the borrower’s assets.
Q. Do you want to venture lenders to invest in a company that is not sponsored by VCs? Are there any exceptions?
A. Generally, venturers only invest in companies backed by securities or reputable investors with future capital to commit. The reason these sponsors are needed is that the company does not usually approach the profitability point and will require additional funding rounds. There are exceptions and it depends on the other strengths of the credit. Eg. Can a particularly strong cash position and strong collateral entice a lender to ease the requirement for ongoing VC support as long as the lender has confidence in the management team. Other factors may also influence the decision.
Question: What are the top four or five characteristics you consider before deciding whether to fund a startup?
A. We look for talented and experienced senior executives, strong VC sponsorship from reputable VCs, a compelling business plan and business track record since inception, an acceptable cash position and burn-rate and acceptable security quality.
Babson MBAs: Mr. Parker, thank you so much for taking the time to talk to us about venture lending. Your lecture has given us an opportunity to gain valuable insight into this exciting industry.
George Parker: It’s been my joy. I hope you find this information useful and that you will consider venture loans as you prepare your career plans. Good luck with your research, and call me if you need more information.