Availability. Most lenders will prefer for all of the loan to be drawn at the Closing Date. Exceptions are tranched loans or delayed draws.
Companies often find the easiest time to raise venture debt is when they are closing an equity round (in particular, an equity round with a new outside lead investor). Some venture lenders will only fund at the same time as a new equity round.
For the lender the new equity is valuable for a few reasons:
- more cash on the balance sheet means the company has more operating runway
- the operating plan will have typically gone under greater scrutiny because the investors are voting on it with their cash. They will have to justify this cheque to their partners
- due diligence materials will be current
- a new lead investor brings:
- a fresh set of eyes to the operating plan;
- another vote of confidence that the company is on the right track;
- a new party to help fund future rounds. This point may be the most important to the lender. With a new lead investor at the table, the pro-rata cheque for all investors just shrunk, making future rounds easier to fund.
Needless to say, venture lenders prefer funding at the time of a fresh equity round. For the company, though, drawing on the entire loan at close may not make sense.
Take the case where a company raises:
- a new equity round sufficient to fund two years of operations, plus
- takes on a three year amortising venture loan.
If the company performs to its plan (note, this may not happen – see below) the company would have repaid debt for two years prior to being able to use the loan for cash burn.
In this case the company would be better served with either an interest-only period or a delayed draw, or some combination of the two. With a mix of a six-month delayed draw and six months of paying only interest the company would have paid back about 1/3 of the principal amount versus 2/3 with a loan that began amortising straight away.
Bear in mind that since not all companies perform exactly to plan, the insurance element of the venture loan has value regardless of the availability period. But in general a company will prefer a longer interest only or draw period.
The lender will prefer no interest only period and all funds drawn day one. With no financial covenant the primary sources of risk reduction for the lender are the principal repayments ability of a company to continue to raise equity. Every month that principal is repaid is one month closer to having made a safe loan.
There are also times where the lender won't want to make the entire facility available from the outset and may prefer to loan in more than one tranche. The next post will cover this case.
Company tip: Build a debt schedule into your cash flows to understand the impact of the financing. Choose a lender that will help structure a transaction to fit your projected cash needs.