Note: Capital Advisors Group is a Boston-based institutional investment advisor that has been helping clients invest their cash assets for more than 20 years. Debt Advisors Group, the venture debt consulting arm of Capital Advisors Group, helps our clients determine their optimum capital structure, identify appropriate lenders, source term sheets and negotiate deals.
The venture lending market occupies a unique niche in the world of venture financing. Because it is less dilutive than equity, venture debt, when used appropriately, may be an attractive solution for a company to extend its cash life. However, there exists a large and disparate group of lenders that vary in quality, service (i.e., how easy they are to work with) and deal preference. Some are specialists that will focus on vertical markets they know well, while others are generalists that will complete deals across industries based primarily on the credit quality of the deal. There are lenders known to slip enhancements into their terms that sweeten the deal for them on the back end, and some that won’t even look at a deal that doesn’t first meet very strict criteria. This paper intends to lay the groundwork to assist borrowers source venture debt to help them objectively view each deal, compare lenders and create competition for their business.
Introduction – History of Venture Debt
Venture Debt was first introduced in the late 1960s for new technology firms that did not qualify for traditional bank financing. These start-up companies not only lacked a proven track record, but also were burning through cash. Historically, the only way such companies could raise capital was through equity financing. Then, a number of equipment leasing companies that were well prepared to maximize the value of certain types of equipment as collateral, began underwriting equipment leases to these early stage companies. In this emerging form of lending, venture debt was collateral driven and almost never reached the 100% financing level for these cash-strapped firms. Finally, in the late 1980s, Equitec Financial Group developed a leasing product that offered 100% financing. Equitec devised the concept of using an “equity kicker” on each deal to increase yield on a portfolio basis to balance the higher risk profile of the borrowers and to offset the inevitable increased loss ratio when compared to bankable credit portfolios. In these early transactions, the “equity kickers” came in the form of success-based fees or warrants. This 100% financing model, which utilized warrants on a short-term basis (typically three years), remains the primary structure used by venture lenders today.
Similar to the significant growth of venture capital investments of the 1990s, the venture debt space grew dramatically. Operating leasing companies that entered the market such as Comdisco, GATX, TransAmerica, Equitable Life Leasing and others fueled growth. Banks specializing in financing early-stage companies also embraced this rapidly growing market. Finally, specialty finance companies were formed to serve and grow within this financing niche. The venture debt market continued its rapid expansion throughout the ’90s and reached its height during the “Internet Bubble” of 2000.
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