Click here for printer friendly page
Venture lending – It's now or later04/04/2007. Source: Israel Venture Capital Journal (IVCJ). 
 Venture lending is relatively new to Israel. In this IVCJ article, Dr Lee-Bath Nelson, senior principal at Plenus Venture Lending answers the most frequently asked questions about this rapidly growing method of financing.
Just what is venture lending?
Venture lending credit facility means a loan, or credit line and loan combination, that is repaid by the company recipient either over time (amortized) or at the end of a specified period (balloon). Such loans or credit facilities are usually offered by venture lending firms to revenue stage high technology companies. In consideration, the lender receives interest, warrants, and a floating charge (or blanket lien) on the company and a specific charge (lien) on the company's IP. This transaction enables companies to raise money at significantly less dilution than through a regular fund raising – music to the ears of both entrepreneurs and existing investors.
When should companies consider venture lending?
Initially, companies need to raise equity in order to fund their development and create an investor base that will continue to provide support. Once a company's products are out in the market, and it is growing, venture lending should be considered alone or in combination with equity. Venture lending is appropriate at the following times:
• As part of a funding round. Rather than raise $10 million in a funding round, a company can raise $7 million in equity and $3 million via a credit facility.
• As an extension to its runway. An example is when a company knows that it will need to raise another funding round in one year, but would like to extend that timeframe to two years.
• As working capital. A company that has sufficient operating cash, but needs cash for working capital, can extend its resources via a credit facility.
• As the last round before an exit instead of, or in addition to, an internal round. The exit amount is fixed and investors/entrepreneurs will receive roughly the same amount with less investment on their part if they take a venture loan. Venture loans can be given for an average period (see below) of up to three years. This is a rather lengthy period for technology companies, and can help in achieving major milestones.
What is an example of a venture lending deal?
Suppose a company has annual revenues of $20 million and is close to breakeven, but needs cash for working capital. The company can receive a $5 million balloon loan or credit facility to give it effective working capital as it grows. The interest would be LIBOR plus 4.5-6 percent depending on the situation. Depending on the loan period and the company, warrants would entitle the lender to purchase $1.25 - $1.75 million of company stock. This means the dilution for the $5 million raised is very small. Alender can invest $1.75 million on top of the $5 million loan for a total of $6.75 million and receive about one-third the equity that a $5 million equity investor would take, or about onefourth of what a $6.75 million equity investor would take.
How big is the venture lending market in Israel?
Venture lending is less prevalent in Israel than in the US. In the US, venture lending is about 15 percent of total VC equity investments. In Israel annual VC investments, including those by foreign investors, are about $1.5 billion. At US rates, venture lending in Israel should be over $200 million annually, but in practice venture lending activity is significantly lower. In Israel, VCs are today suggesting venture lending to their portfolio companies in addition to or in place of a funding round. Venture lending is unquestioningly becoming more popular, and it seems that the vast majority of VC-backed companies that are currently raising funds are considering the venture lending route.
What should companies look for in a venture lending facility?
When a company considers venture lending, it should have a clear picture of its cash needs and their timing, so that the lender can structure the credit facility for the company's specific needs. The best way to consider a venture loan is to do a detailed cash flow analysis of the company's expected cash flows (plans) with the loan superimposed on it. This analysis should take into account any fees (initial, annual, or termination) as well as interest. Once this analysis is performed, the company can compare the bottom line to determine how much more cash the company would have (compared to the original plan) when the company needs it most. In addition, this analysis enables the company to see if it can delay fund raising and for how long, thanks to the venture lending. Another interesting measure to look at is how much of the loan, net of fees and interest, is still outstanding at the point of minimum (or $0) cash in the company's original plan.
What other loan parameters should the company check?
A loan or credit facility has several components that companies should consider:
• Average Period – the point of time at which half of the loan has been repaid. The loan's average period is calculated by taking one month for every balloon or credit line month plus 1/2 a month for every amortized month. So, for example, a loan that is balloon for 12 months and then amortized for another 18 months has an average period of 21 months. Another way of describing this loan is as a 30-month amortized loan with a 12-month grace period.
• In order to compare various loan offers in terms of warrants. there are two parameters that can be checked:
- warrants per year in the average period
- warrants per additional $1 million at the time the company runs out of cash in the original plan. For example, if the company plan says it runs out of cash on January 1, 2007, and with the loan, the company has $2 million at that point, then the warrant amount should be divided by two.
Are there any non-numeric parameters to consider?
When choosing a venture lender it is important to choose a partner that has a reputation for working with portfolio companies and being flexible when things don't quite go according to plan. That is the time when the company needs all of its resources and the support of all its investors. The last thing it needs is a rigid, by-the-book, venture lender that calls its loan and pulls the carpet from under the company. It helps when the professional team at the lender is high-tech oriented and understands that in this sector, markets and companies have ups and downs.
This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com
|
