Risk Loans: Babson MBAs Get Insight on Risk Debt Financing
Recently, several students from Babson College’s MBA program called to request an interview. They were researching the venture debt market and wanted an inside look at how this segment compares to venture capital. His questions were thoughtful and I thought the discussion was worth sharing. An excerpt from the interview appears below:
Q. How are Venture Loans (BV) different from Venture Capital (CV) when it comes to fundraising expenses?
A. Fundraising expenses related to venture loans are generally lower than those for venture capital transactions. Legal fees are one of the largest expenses in many transactions. Lenders often negotiate risk loan agreements using their standard documents. However, venture capitalists often use newly created stock purchase agreements. These agreements add considerable expense to these transactions, as external legal advice is used. Other venture capital expenditures 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. Generally, collateral is not required and there are fewer settlement agreements than are required by lenders. Venture loans often limit the use of proceeds to acquired 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 LV companies that focus on segments other than technology or life sciences (eg, retail, restaurants)?
A. Currently, there are not many risk 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 risky loans or leases. Most are involved in the segments you mentioned.
Q. How long does it normally take to get money from a risky lender? How many visits must an entrepreneur make to a venture lender before a final decision is made?
A. Most risky loans take at least thirty days to complete from the time the prospect is met to the actual financing. 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 started due diligence?
A. Yes, but lenders disapprove of purchases due to the time they spend processing the transaction. The norm in business is to link a transaction with a letter of commitment and a fee. If the borrower / lessee continues to shop and chooses another provider, they will generally lose the fee.
Q. Ideally, at what stage would an entrepreneurial company be considered safe for risk loans (for example, a startup seeking the first round of financing or a company that already has a first round of equity and is seeking a second round)?
A. Most venture lenders get involved after the business has successfully raised at least $ 5 million or more from a reputable venture capital sponsor – that is, after round A.
Q. What are the collateral requirements for a “growth capital” loan?
A. Warranty requirements vary. Some venture loans / leases are specific guarantees. The lender requires a collateral in the form of equipment that is financed. Other transactions are more flexible, allowing income to be used for general growth and working capital purposes. In later agreements, lenders may require an all-assets (“general”) link to the borrower’s assets.
Q. Would venture lenders invest in a company not sponsored by venture capitalists? Are there exceptions?
A. Generally, venture lenders invest only in VC-backed companies or reputable investors with future capital to commit. The reason these sponsors are needed is that the business is generally not approaching the point of profitability and will require additional rounds of funding. There are exceptions and it depends on the other strengths of the credit. For example, a particularly strong cash position and strong collateral may induce a lender to relax the requirement for ongoing venture capital support as long as the lender has confidence in the management team. Other factors can also influence the decision.
Q. What are the top four or five characteristics that you consider before deciding whether to fund a startup?
A. We are looking for talented and experienced senior managers, strong VC sponsorship of reputable VCs, a compelling business plan and business track record from inception, an acceptable cash position and consumption rate, and acceptable warranty quality.
Babson’s MBA: Mr. Parker, thank you very much for taking the time to speak with us about risky loans. Your talk has provided us with an opportunity to gain valuable insight into this exciting industry.
George Parker: It was a pleasure. I hope this information is helpful to you and that you consider risky loans as you develop your career plans. Good luck in your research and give me a call if you need more information.