Venture lending is what we do at CLP and I will post a number of topics about venture lending here. If there is anything you want to see or discuss please suggest it in the comments of any post or email me directly.
To start let’s walk through an overview of what venture debt is and talk a little about how it differs from traditional lending.
Venture debt is a special form of term loan (discussed earlier) given to startups. In its most standard form a venture loan is advanced when a new equity round is raised.
The venture loan has two purposes:
- extend the runway of the equity round, and
- act as an insurance policy in case the company needs more cash than it originally planned for.
A venture loan is typically paid back over 36 months. The money is “spent” in the first fifteen to eighteen months of the loan. The cost is well below that of equity. The lender will want a closing fee, interest coupon and a small amount of warrants (options, typically exercised into the same shares issued to the VCs with the lender paying for those share at the same price the VCs paid).
For this to work the venture lender has to look at credit differently than a traditional bank or term loan fund would. The profile of startups is almost the opposite of what constitutes a safe credit:
- startups burn cash;
- startups have few assets on the balance sheet;
- startups operate in an uncertain environment. Technology, customer needs and competition change constantly.
Not only is the profile of startups difficult for traditional lenders to work with, the structure of traditional loans does not work for startups. For example, a traditional term loan will have financial covenants allowing the lender to take corrective action if the borrower significantly underperforms.
But a startup can have a bad quarter, or more, as it adjusts its strategy and growth plans. In order to work with startups, venture lenders will typically have no financial covenants.
So how does this work?
A traditional lender will place heavy emphasis on underwriting “coverage” of profitability (such as EBITDA levels and debt/EBITDA multiples) and balance sheet (liquidation value of current and long term assets).
In contrast, a venture lender will rely more on fundability (will VCs continue to fund this company) and going concern value (if growth stalled and VCs stopped funding who would likely buy this company and what would it be worth?)
Venture loans are available from funds, like CLP, and banks who specialize in working with tech companies. Silicon Valley Bank [SIVB] is the most established and largest of the tech-focused banks. They have offered venture debt for over twenty years. Other banks include Square 1 Bank [SQBK] and Comerica Bank [CMA]. In Europe, the success of SVB has led to Barclays Bank [BCS] and Clydesdale Bank to offer venture loans.
At any time there are up to a dozen funds offering venture debt (in contrast to the hundreds who offer venture equity). Most of these funds are backed by limited partners in the same way venture equity firms are. These would include WTI, Lighthouse, Wellington Financial, Escalate in the United States and Kreos, Harbert and Columbia Lake Partners in Europe.
There are a few publicly traded pure-play venture lenders which I will reference when we discuss deal terms later. Hercules [HTGC], Horizon [HRZN] and TriplePoint [TPVG].
- startups can access term loans, “venture debt” as a complement to equity and with a lower cost than equity;
- unlike typical bank loans, venture debt typically has no financial covenant;
- the loan is typically used in the first 15-18 months and repaid over 3 years;
- specialist banks and funds provide these loans.