Visits to venture capitalists (VCs) are
among the first order of business for
entrepreneurs seeking to get a business off the ground.
These seasoned investors with an eye for
the next home run often are the initial
source of funding for neophyte businesses
seeking to take a novel idea and morph it
into a marketplace behemoth. As savvy
pros in the high-stakes seed-financing
arena, the investors also hold back subsequent rounds of funding until they see
progress on a business plan.
Often, the business owner needs additional funds to tide him over during the
period between one round of funding and
another. This is where a commercial bank
can assist with venture debt financing.
Smart Business spoke with Phil Koblis,
first vice president of the Technology and
Life Sciences Division at Comerica Bank,
about how venture debt financing helps
provide the “additional runway” to firms
waiting to tap the next round of capital
from their major investors.
What is venture debt?
It basically is a cheaper cost of capital.
Less expensive than raising money from a
venture capitalist, venture debt helps businesses continue to hit their major milestones as money from an earlier round of
financing is depleted. Venture debt loans
are loans made against a company’s assets
and typically provide the runway between a
first and a second round of financing.
Most start-ups need to do business with a
commercial bank at some point, even if
they have venture capital backing, because
they usually are in an infancy stage and
have very little cash flow. They depend on
their venture capitalist for nearly all their
operating needs. Our loans help supplement their burn rate for one to two years
until the VC steps in with additional dollars.
How do you assess the creditworthiness of a
start-up company?
We usually come in only after a business
has secured the commitment of a major
institutional venture capitalist. The factors we evaluate include who is providing the
venture capital; the individuals who form
the management team at the company, their
track record and their history of business
success; and finally, the business idea itself.
The original equity investor already has
done a lot of due diligence before committing his money. And we hold their decisions
very highly because they typically make
good investments. But we also meet with a
company’s management several times to
discuss their business plan, ensure that they
are on track in hitting their milestones and
we review all their financial statements.
One of the keys in providing these loans
is understanding the quality of the VC firm.
We need to know that the VC has a certain
amount already allocated to the business
for its next round of financing. We know
which of these firms will go through thick
and thin for a company by following
through on initial investments.
There is a bit of a process of educating
both the business owner and the bank
about the expectations one has for the
other. How will a venture debt loan help
push the business plan along and how confident is the owner that he can raise additional funds from the VC? Ultimately, we believe that the strength of our business lies
in our ability to actively partner with both
the business owner and the venture capitalist to help ensure that their expectations of
the business can realistically be met.
How long does the process take to secure a
venture loan and how is it secured?
It might take between three and eight
weeks on average to close a loan. During
this time, we ensure that the business is
plugging along in the right direction, that
the VC is still interested in the business and
that we have sufficient security in the firm
if we need to claim its assets.
Our loans on average range from $1 million to $5 million. For biotech firms, the
amount is about $5 million to $10 million.
On average, a loan is amortized over three
to five years. Once a business finishes
drawing down its loan, it has about 36 to 48
months to repay the loan amount.
From our perspective, we should have the
confidence that the VC will come in with its
financing once our amortization schedule
kicks in. We also take a little bit of stake in
the company through warrants to buy
shares at a future date, and this can help the
firm in getting a better price on the loan.
At the end of the day, we take a risk in
providing a loan. We are not gaining equity
in a firm and expecting to make money
once a business is sold.
Why has it become such an attractive option
for companies lately?
A couple things make it so popular. First,
the availability of venture debt has grown
as new providers and more dollars have
entered the market. Second, the cost of
this form of capital is still very low as compared to equity. At the end of the day, if the
companies and venture investors involved
in those companies use the venture debt in
the proper way, they should be able better
maximize their investment returns upon a
liquidity event.
PHIL KOBLIS is first vice president, Technology and Life
Sciences Division, at Comerica Bank. Reach him at (415) 477-32622 or a [email protected].
