Are you overlooking your foreign currency risks?

Nearly all S&P 500 companies discuss foreign currency risk and hedging activities. However, any business that is competing, buying or selling services and/or products internationally, regardless of its size, faces some form of economic risk attributed to currency movements. Even if companies are transacting internationally in U.S. dollars only, they are still subject to foreign exchange risk.

“One of the biggest challenges companies face is the ability to identify and quantify their foreign exchange risk exposures,” says Jim Altman, middle market Pennsylvania Regional Executive at Huntington Bank. “This is particularly true of economic risk — the competitive advantage or disadvantage resulting from exchange rate fluctuations that impact the value of a firm. Even those that can identify their exposures face the issues of optimizing their hedging strategies or forecasting their future exposures.”

Smart Business spoke with Altman about foreign exchange risk and strategies to hedge against it.

What are the first steps to hedging the impact of foreign currency fluctuations?

An effective strategy is to lock into a forward contract or enter into an option contract. These strategies allow companies to lock in exchange rates today to settle contracts in the future and can mitigate currency exposures currently on the books or expected future exposure. Hedge accounting rules may also play into companies’ hedging policies, if applicable.

What are the more common hedging strategies?

Most companies implement a foreign exchange risk hedging program to reduce earnings or cash-flow volatility. Given this objective, it’s wise to create and implement a formal hedging program, which includes establishing a foreign exchange policy.

For example, the program may seek to hedge 100 percent of foreign currency receivables/payables currently listed on the balance sheet. Additionally, the company may also forecast foreign exchange risk exposure out one year. However, if the company does not wish to hedge all exposure, as many do, the plan may include hedging 75 percent of anticipated exposures less than six months out and 50 percent of anticipated exposures six to 12 months out. This is called a tiered hedging approach.

Often companies ask if it is best to hedge all known exposure at one point in time, called a static approach, or if they should layer on hedges — a dynamic approach — throughout a defined time period while blending the varied rates. It is important to consider the level of confidence in forecasted payables and receivables to decide which strategy is best. When considering an approach, it is important to define what percentage of ‘core’ hedges should be locked-in vs. the percentage that should be ‘tactical’ or market driven hedges.

What should companies know and understand before hedging their foreign currency risk?

Throughout the risk management process, the most challenging step can be exposure identification. Foreign income translation can be challenging to hedge, but it may be the cause for unwanted cash-flow fluctuations. Meanwhile, other foreign exchange risk exposures may go completely unnoticed. For example, a company that sells internationally in USD would be extremely vulnerable on a competitive scale if the U.S. dollar rallies broadly. Conversely, if a U.S. company is sourcing overseas in U.S. dollars, it may be over-paying, prompting price concessions.

It is also important for a company to know and understand their tolerance for foreign exchange risk. It is not always advantageous for a company to hedge all of its exposures. Comfort with a specific earnings-at-risk or cash-flow-at-risk will help prevent over-hedging.

Developments in technology and globalization mean the world is increasingly becoming a single market. Often, companies grow faster than their comfort level in managing associated foreign currency risks. Fortunately, the foreign exchange risk market is extremely accessible to businesses of any size, and banks’ foreign exchange risk advisory teams can help tailor risk management solutions that best fit companies’ ever-changing needs.

Insights Banking & Finance is brought to you by Huntington Bank

How to identify the right banking partner for your technology company

Since 2009, there has been significant growth in the number of new technology companies as a result of an increased amount of capital available to entrepreneurs through venture capital, growth equity and corporate investment.

Technological advances have made it easier for companies to create and scale their businesses, and has contributed to the amount of new tech companies present today.

But what about the actual business of creating these innovative products? Most startup companies face a plethora of administrative challenges. Investor-backed technology companies typically have a finite amount of time and capital to create value and attract subsequent equity investment. As a result, they are forced to be thoughtful when selecting service providers.

Smart Business spoke with Peter Haman, Vice President and Relationship Manager for the Technology Banking Division at Bridge Bank, about what technology companies can do to identify a suitable banking partner.

Where should technology companies begin their search for a bank?
With over 6,000 banks in the U.S., there are only a handful of banks that provide complete banking services to technology companies and even fewer that do it consistently.

Within the small group of banks that do provide treasury and credit services to technology companies, many dedicate more time to providing services to investors or the investors’ funds. Technology companies need to consider a bank that has a primary focus on what it does rather than those banks that support the broader technology industry.

Second, once the companies move beyond the limited scope of banking options, there are a number of operational challenges that are unique to technology companies. For most seed to early-stage companies, the primary goal is validating the product or business model through an initial product launch or through early sales traction.

Given these goals, combined with the traditionally limited resources these businesses have to employ a full-time finance professional, banking becomes a low priority for early technology companies. Having a banking partner that has the experience to recognize these priorities and can help guide the founding leadership team is important.

Equally important is selecting a business bank that has an intuitive platform and a responsive relationship team that acts as a trusted counselor to the leadership team.

What happens as the process to grow the business moves ahead?
As technology companies validate their business models, the priorities for the business often shift to boosting sales as a way to attract further investment.

Scaling rapidly can create several operational challenges. So the third piece of the puzzle should be to find a bank that can identify the business’s growth trajectory and proactively recommend treasury solutions to help address and automate part of these operational burdens.

During this same time, business banks are able to begin extending credit given a company’s sales traction or capital investment by institutional investors. The type of credit most often provided solves two main challenges with scaling companies: working capital and runway extension to the next equity event.

Technology companies should seek out a banking partner that can tailor credit solutions to the business objectives and anticipate future capital needs.

Finally, when technology companies begin to reach scale and they can dedicate more time to long-term objectives, their banking partner should be strategizing and collaborating with the leadership team to ensure the appropriate products and services have been implemented to meet these long-term goals.

A bank specializing in technology businesses should be able to asses an organization and recommend account structures and services to best meet the client’s needs. The type and amount of credit a bank can extend impacts a later stage technology company’s ability to execute on strategies or implement cost-effective capital solutions.

Most technology companies are challenged with universal issues whether it’s fundraising or solving growing pains. An experienced business bank should be able to identify these challenges and deliver the appropriate solutions no matter the life stage or market segment that applies.

Insights Banking & Finance is brought to you by Bridge Bank

How to ensure a smooth transition as your company automates its processes

Automation affords companies the opportunity to provide more efficient service to customers, but caution must be taken with the manner in which this efficiency is achieved, says Matthew Berthold, Executive Vice President and Chief Administrative Officer at Westfield Bank.

“A lot of the larger banks follow a mass banking strategy with banks located everywhere, which is the traditional way of banking,” Berthold says.

“There are some customers who like that connection and like to be able to go to the office to do their banking. Others appreciate the growing movement toward self-service banking that utilizes automation. Every bank, and every business, needs to figure out how to deliver its own products and services most efficiently in a way that satisfies its customers.”

Berthold has been working on an in-depth project this year to automate processes at Westfield Bank. One of the most valuable lessons he has learned is the importance of always keeping the end customer in mind as decisions are being made.

“It’s important for us to look at all the processes that aren’t a value-add to the customer,” Berthold says. “It’s really trying to eliminate those non-value-added parts of the process.”

Smart Business spoke with Berthold about how to make automation work in your business without upsetting customers who value a more personal touch.

What are some helpful tips for companies looking to automate their processes?
One critical component to any change management strategy is an upfront dedication of resources to the task at hand. You need to completely commit to the investment to create buy-in throughout the process to ensure that you’re adequately addressing all the key concerns that may be out there.

If you’re not allocating the necessary resources and engaging the right people who have a stake in the change you’re considering and if you’re not using that input to guide your decision-making process, it becomes much more difficult to achieve your goals.

As part of that soliciting of feedback, you also need to examine the end-to-end processes you are targeting to automate. Be clear about what you have and compare it to what you’d like to achieve. In other words, you need to know where you are before you can determine where you want to go.

There are typically a number of steps to any process. You need to take a methodical approach to ensure that the new and improved process you formulate really is just that, a better way of completing the job. Metrics can play a key role in this step by giving everyone specific targets to aim for and goals to measure the success of the new system.

For example, there are certain steps that are part of extending a loan to a customer and there is a certain order in which those steps need to be completed. If you’re a bank and you don’t take a comprehensive look at the process and study how to make the transition, you may not gain the efficiencies you had hoped to achieve.

Finally, you need to alleviate fears that may be out there about what automation could mean to an employee’s future in the company.

It’s easy for non-management personnel who aren’t privy to all the details to view automation as an effort to reduce costs by eliminating positions in the organization when the end goal is actually to reduce costs by creating efficiencies.

Focus on what is being gained. Explain that automation will enable team members to focus on other tasks and in the process, make the company stronger.

How do you know if you’re maximizing the potential of automation?
When you’re dealing with new systems, there is often a learning curve to understanding their functionality and capability.

The dedication of resources is again important in this area to ensure that you’re making every effort to get the full benefit of the system you’re implementing.

You want to get what you paid for, so work with your vendors and make certain that they have delivered a product that meets your expectations.

Take advantage of their expertise to help you and your team understand how to use all of the processes that are now available through the new system. ●

Insights Banking & Finance is brought to you by Westfield Bank.

There’s no risk in hedging, but much risk for companies that don’t

Hedging for companies that buy or sell commodities helps protect a company’s cost of goods sold or top line revenue. It allows a company to lock-in the price of a particular commodity for a certain period of time to limit exposure to unexpected price swings that could negatively impact budgets and bottom lines.

“Good candidates for hedging are midsize companies, especially those buying a lot of fuel, metals or agricultural products, for instance,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “It also applies to businesses that bring in specific commodities, value-add such base-metals like aluminum or copper and move them out, which means they’ve got to inventory their price risk. Anyone directly purchasing commodities should have a hedging strategy. If commodities are a big cost component, companies should use every tool or strategy available to de-risk their purchases by stabilizing pricing.”

Smart Business spoke with Altman about commodities hedging, how it works and what companies that purchase commodities should consider to mitigate their price risk.

Hedging can help protect gross margins from wild or inconsistent swings in prices. How does this work?

Financial hedging to reduce price risk means decoupling the physical commodity from the price component, which tends to fluctuate. How a company buys the physical materials doesn’t change. It’s about the financial hedge reaching a settlement that gets them back to a price that’s stable and reliable.

When hedging, companies buy a commodity at a locked-in rate over a defined period of time. At the end of each month, there’s a gain or loss versus where commodity index settled. If the company is a buyer of a commodity and the price goes higher than the set rate, a settlement comes back to the company. If there’s a loss on the hedge the company can still realize a gain in the physical buy — there’s a settlement in the market that’s offset by the lower prices.

Midsize companies are typically worried about a spike in diesel prices that they can’t pass on to clients. Some of these companies may burn 100,000 gallons per month, so they don’t want to risk a spike of 50 cents. Putting a financial hedge on that commodity offsets any price change on the diesel index.

What do those interested in commodities hedging need to understand or consider before they participate?

Companies must understand their price risk. In transportation, companies buy diesel but may or may not be able to pass on or surcharge their customers for any swing in prices. What’s important is defining the price risk the company will bear — that which it cannot pass on to customers — then setting up a strategy to hedge that risk.

It’s a gut-check question. Companies should recall the last time gas went up to $4 per gallon and how that affected them. Those costs likely couldn’t be passed along to customers.

Be honest about how much of an increase the company could absorb. Define what part of that increase the company might be able to pass along. Are margins being protected? Taking price variability off the table will help set the strategy for the hedge price and how long it should be hedged for.

What are the factors that determine a company’s hedging strategy?

Many companies don’t understand they have exposure until it’s too late — for instance, after a price run up. That’s why it’s important for companies to understand their exposure.

Those that are worried about their budget in 2017 should set a budget for their commodity purchases in the third quarter and then hedge the cost. It’s a best practice to have a hedging strategy that reaches out 24 to 36 months, which allows the company to average out the dollar cost and mitigate the volatility in commodity pricing. A company could decide to be 75 percent hedged at first then taper down as time moves on. But don’t quit hedging.

Do an annual review. Check to make sure nothing has changed in the exposure. Check to see if contracts and risks are the same, if line items have changed and that the strategy is in line with exposure.

Hedging is good insurance. It also helps companies be more thoughtful about their exposure, and determine a strategy to reduce that risk.

Insights Banking & Finance is brought to you by Huntington Bank

Why good times are the best time to get a line of credit for your business

One of the biggest mistakes you can make as a business owner is to put off securing a line of credit. Sales are growing, product is flying off the shelves and business couldn’t be better.

It may not seem like it, but it’s actually an ideal scenario to sit down with your bank and discuss a line of credit, says Ben Fargo, Vice President, Capital Finance at Bridge Bank.

“The best time to get a line of credit is when you don’t need it,” Fargo says. “When you’re profitable and your balance sheet and income statement are strong, you’re going to be able to negotiate the best terms for your line of credit.

“Think of it as an insurance policy for your business. When you wait and you get into a situation where you’ve gone from being profitable to losing money and you’re trying to figure out how to turn that corner, you’re going to have a much more difficult time.”

Smart Business spoke with Fargo about what to consider when pursuing a line of credit and what it should be used for once you get it.

What are the most common reasons to seek a line of credit?
Typically, a line of credit should be used for working capital purposes and short-term needs. A good example would be consulting companies. They have employees they need to pay today, but often they are not going to be paid by their customer for 30 days. These companies can leverage a line of credit to make that payment today.

One of the worst things you can do is to use a line of credit to purchase new equipment. Let’s say you have a $1 million receivable-based line of credit and you leverage that on day one to buy $1 million worth of equipment.

Now you have that $1 million debt outstanding — and not revolving or amortizing – and a real need arises to cover a critical expense in your business. This unexpected need is exactly what a line of credit is designed to cover, but your line was used to buy equipment — and you no longer have the borrowing capacity.

What are important considerations when negotiating a line of credit?
Think about the size of the line of credit and whether it’s something that will accommodate the growth of your business.

Does the borrowing formula that the bank is proposing allow you to maximize the amount that you can borrow against the asset — whether that’s accounts receivable, purchase orders, inventory or some other type of asset? As a borrower, do you understand what’s being considered as eligible for you to borrow against?

Say your company has $1 million worth of receivables. At an 80 percent advance rate, this would imply $800,000 of availability. But what is considered eligible versus non-eligible? Does your business pre-bill customers and send an invoice before you’ve delivered a product or service?

If you’re not going to deliver for 30 days, is the bank going to consider that receivable eligible in your borrowing base? Depending on the eligibility criteria, the amount that you can borrow may be drastically different than the amount of the commitment.

Another question, believe it or not, is whether you can actually borrow on the line of credit. Is that $1 million of receivables really $1 million of borrowing capacity or would drawing on the line of credit potentially cause a covenant default with a term loan?

Maybe the increased draw on the line creates an increased interest expense which impacts your company’s ability to meet a required debt service threshold, or perhaps the draw would cause overall debt levels to be too high, causing a breach of a leverage covenant.

What’s an important piece of advice to avoid problems with your line of credit?
Make sure you absolutely understand the terms and conditions of the line of credit. Whether that’s financial covenants or the computation of the borrowing base and what you’re allowed to include versus what isn’t included.

That will ultimately impact how much you can borrow. Don’t be afraid to talk to your banker about how the line of credit is structured. Make sure the bank understands your business so the line of credit is legitimately adding value and can help your business versus hinder it.

Insights Banking & Finance is brought to you by Bridge Bank

Making a difference: The role of a community bank

The essence of community banking can be easily summed up in one simple phrase: “We are you, you are us.” As you make your way through your town, village or city, the echoes of this statement can be felt and seen in everything you do on a daily basis, says Scott Dodds, Executive Vice President and Senior Loan Officer at Consumers National Bank.

“A community bank takes great pride in being a part of all aspects of a town by employing its people and supporting the financial needs of businesses, farms and schools,” Dodds says.

“Community bank employees volunteer and the bank makes donations to local nonprofit organizations. They help keep the local economy vibrant through returning dividends to shareholders who do business with the bank. They make investments and support financial decisions made by people who know the community. They know these businesses because they live in the same community.”

Smart Business spoke with Dodds about the different ways in which community banks can support their local economy.

Who benefits from the presence of a community bank?

When you consider the different industries and service providers that allow a community to thrive, just about any one of these entities are supported by a community bank. When you see new homes being constructed and young families moving into starter homes, they are often financed with various types of mortgages offered by a community bank.

Businesses receive strong support from a community bank’s advisers who understand the market and often play an active role in financing the building in which the company is located. The bank also provides ongoing working capital that supports both the business and the broader economy.

Schools are able to keep their infrastructure updated and offer students state-of-the-art technology to boost student learning experiences thanks to support from community banks. And in many smaller communities, the milk, cheese, meat and produce that consumers purchase is grown on farms that receive agricultural lending support from their community bank.

Finally, nonprofit organizations benefit from the time, talent and treasure provided by a bank and its employees who support a community bank’s mission to give back to the communities that they call home.

What responsibilities does a community bank have to the town it calls home?

Community banks will pay attention to all of the opportunities that exist in the regions they serve, no matter the industry, in order to ensure those businesses receive the capital they need to grow and thrive. Community banks raise both capital and deposits locally to fund their institutions and maintain the infrastructure of the bank.

That capital can also be used to hire people who can then volunteer and serve in the community and help it be a better place for everyone. Community banks also provide unlayered management, meaning customers in the area have closer access to the people in the bank who have the ability to make decisions in an advisory capacity. The bank’s advisers should know and consult with the local business owners and help provide needed capital critical to their success as they grow.

Community banks can also provide a more personal touch since they are typically headquartered in or near the same communities they serve. The business development officers and management take an active role in attending community functions and local volunteering.

Community banks should be aware of their local economies allowing them to understand the nuances of the industries for more thoughtful, informed decisions that can help a community continuously take steps to strengthen its economy. Applications are reviewed by employees who know and live in the area asking appropriate questions and resolving any concerns. Community banks also employ your neighbors and reward local shareholders by paying dividends from profits made keeping the cycle of money in your community.

Insights Banking & Finance is brought to you by Consumers National Bank

A look at payment methods — their costs, risks and benefits

Companies of all sizes tend to face challenges when it comes to managing working capital.

“Suppliers want to be paid quickly for services, but companies want to pay slower to keep more cash on hand,” says Jim Altman, middle market Pennsylvania Regional Executive at Huntington Bank. “The interests of both parties need to be considered as part of the business relationship.”

Smart Business spoke with Altman about cash flow management and payment options that benefit both payers and suppliers.

What are some common payment methods?

The most common payment method is issuing checks. They generally require little more than the recipient’s mailing address in order to effect payment. Checks typically include a check stub that provides remittance detail for the recipient to close out their receivable, but the manual data entry process to record the check stub detail is laborious and subject to error.

ACH and wire transfers require the recipient’s bank account information to complete the transaction. ACH has no easy way to transfer remittance information to the supplier. Wire payments have the same issue and they’re expensive to process, so it’s often not ideal for payers.

Commercial cards are also relatively simple for the payer and receiver once the receiver is capable of processing card payments, however there are fees incurred by the receiver to do so. Detailed remittance information is provided with the card transaction. Payers are willing to send commercial card payments to their suppliers earlier than any other method since they do not need to actually fund those payments until their monthly program cycle ends. Those faster payments make the processing fees worth it for many suppliers.

How does each payment method stand up to fraud?

If checks are intercepted or even momentarily viewed, fraudsters can create fraudulent checks and use them for their own purposes. Seventy percent of payments fraud occurs using checks.

There are multiple methods for fraudsters to gain access to online ACH and wire transfer credentials and then move money from company accounts.

Commercial cards, particularly virtual cards, are the most secure. Payments are made through one-time use cards that are allocated for a specific supplier in a specific amount. It’s very hard, if not impossible, for fraudsters to intercept.

What are the costs of these different methods of payments?

Typically, the cost of a wire transfer for the payer is $10 to $20, ACH is about 25 cents and checks cost between $1 and $3. With commercial cards, the cost primarily falls to the recipient. Commercial cards have the advantage of a revenue share program that comes back to the payer. These rebates can be monthly, with a percentage of dollars put on the card program coming back to the payer in cash. There are often annual bonus rebates if the spending volume crosses a predetermined threshold.

Commercial cards also offer a use of funds gain for the payer. Payment is made in a day, satisfying the supplier, while typically giving the payer a 30-day period to pay the bank.

Conversely, funds transferred by wire are gone the same day, ACH moves funds one day after a transaction is submitted, and checks have to be funded within three to five days of issue.

What should companies consider as they negotiate payment terms with vendors?

Payment timing is a big factor in these negotiations, as is the impact of competition. Many suppliers see card acceptance as a cost of doing business. There is a supplier enablement component to many commercial card programs where the payer’s bank will contact the supplier on the payer’s behalf to see if they will accept card payments.

While each method of payment offers its own unique advantages, businesses with annual accounts payable volumes of $5 million to $500 million may ultimately find it in their best interest to maximize the use of commercial card for payments, given that it’s the most cost effective and efficient form of payment for both parties and is the most resistant to fraud.

Insights Banking & Finance is brought to you by Huntington Bank

What to do when you have concerns about your bank

The changing landscape of banking in Northeast Ohio has led some customers to re-evaluate the relationship they have with their bank, says Kevin Vonderau, Executive Vice President and Chief Lending Officer at Westfield Bank.

The one thing you can’t do when you have concerns about your bank is to pretend that the problem doesn’t exist.

“You have to confront it head on and have an honest conversation with your banker,” Vonderau says. “Identify your concerns and work with your banker to resolve them. If you can’t, it may be time to see if there is a better banking partner out there for you.”

As a business customer, there are a number of factors that should be considered when you begin assessing the possibility of changing banks. You need to take the necessary steps to ensure that you’re making an informed decision that will protect your future.

“You don’t want to go from bad to worse; and remember that it takes time to transition and develop that relationship,” Vonderau says.

Smart Business spoke with Vonderau about how companies should respond to concerns about the relationship they have with their bank.

What is causing changes in the way banks do business?
Like every business, banks are looking for ways to eliminate overhead whether it is the consolidation of offices or through mergers and acquisitions. Technology has had a major impact on banking by providing customers with anytime, anywhere accessibility and mobility.

The use of technology has decreased the amount of traffic coming into the banks, which means you see offices consolidating which also decreases the number of places where a customer comes in direct contact with a banker. Technology is good for many customers, but it can’t replace the need to be available when a customer needs to talk to a banker in person.

Banks see the need for physical locations, and at the same time, they recognize that millennials have replaced baby boomers as the largest population in the workforce. Millennials look for and expect the latest and greatest technology for customer interaction and on-demand accessibility. Banks must meet the changing needs and expectations of all their customers.

What can businesses do to adapt to these changes?
Establish good relationships with more than one person. Working with a team means you have several resources to rely on to make sure your banking needs are being met. It also helps maintain the relationship if a banker retires or leaves the bank. Strong relationships require give and take from both sides. But the result of loyalty and staying faithful to each other is a team that will work together to make your business stronger.

What if you decide it’s time to consider changing banks?
Look at what is going to create the most value for you and your business while providing the service you want. Value isn’t always the cheapest price; value is what you get in return for your investment of time and money.

Service is a huge component in banking, so look for bankers who have the authority to make decisions which can provide you with answers more quickly and save you valuable time. Consider the automated or electronic processes that you currently have in place; those will have to be transitioned and reset when you move to a new bank.

Take your time and make sure you’re making the right decision before you move; you don’t want to keep jumping from bank to bank to bank. Research and determine both the value and service offered by each bank you are considering.

Keep in mind that there will always be issues during the transition. Talk to potential banks to find out what available resources they provide to create a smooth transition. Talk to your financial team; include your business partners such as your accountant and attorney. You want everyone to be on the same page.

If you are going through tough times, it’s a lot easier if you have a team of good people surrounding you to help you through it. Get input from other business owners on their banking relationships. Chances are they had the same questions you have and they may have found some answers. ●

Insights Banking & Finance is brought to you by Westfield Bank

Venture debt can be a good option to fund medical device technology

Venture debt has long been a favored source of non-dilutive capital amongst life science companies, particularly medical device companies. Why?

Venture capital investing in medical devices and diagnostics has traditionally lagged biotech by more than half, says Justin McDonie, senior vice president and managing director at Bridge Bank.

“Total venture funding for medical device companies declined following the 2008 recession and never recovered, even as funding has rebounded elsewhere,” McDonie says.

According to a recent MoneyTree Report by PricewaterhouseCoopers (PWC), a total of $2.8 billion was invested by venture capitalists in medical devices and diagnostics in 2015. That’s the highest annual sum for medical device and diagnostic venture investments since 2008.

However, investments in this sector are poised for another down year with $1.1 billion invested across 119 deals through the first six months of 2016. Compare this to biotech with $3.7 billion invested across 224 deals for the same six-month period.

“While medical device development follows a well-established development path, the length of time required for 510(k) clearance and PMA approval has increased,” McDonie says. “According to a Stanford University report, it’s estimated that the average cost to bring a low-to-moderate 510(k) product from concept to market is $31 million, while high-risk PMA costs average $94 million.”

Smart Business spoke with McDonie about how the lack of venture capital dollars for medical device companies creates opportunities for venture debt to augment venture capital dollars to fund medical device technologies.

What other factors have driven the investment disparity between medical devices and biotech?
There is a lot of reimbursement uncertainty in the U.S. In addition, under the Affordable Care Act (ACA), a new medical device excise tax was enacted which is a 2.3 percent tax on revenue for device manufacturers. That’s a pretty regressive policy.

The tax is under a moratorium for two years, but in terms of the venture capital view, and because it is viewed as regressive, it’s a tax that hampers the cash flow of cash-burning startups and thereby hinders the length of time that a VC firm has to recoup its investment dollars.

Several venture capital firms have said they’re not going to invest in medical devices anymore or have pivoted towards investing in later-stage device opportunities where there is a clear reimbursement pathway and shorter exit horizon.

Investors are not willing to spend tens of millions of dollars fighting a reimbursement battle. If you look at biotech valuations versus medical device valuations and the multiples on return, those multiples are significantly less for medical devices than biotech.

With the uncertainty in the reimbursement world as it relates to devices, coupled with the lack of venture dollars and LP dollars that are allocated to device venture funds, funds have either turned toward biotech only or later stage medical device or health care services.

What is the key to maximizing the value of venture debt?
You need to be clear about the problem you are trying to solve by adding leverage to your balance sheet. Is it pure balance sheet bolstering for a company that might be entering into strategic negotiations? Or is it bolting on capital that is going to provide runway extension?

Often, venture debt is funded alongside an equity component; you can augment with equity to reach the same financing target, allowing VC’s to keep more equity dollars on reserve should future funds be needed. For example, and for the sake of simple math, if a company raises $12 million and is burning $1 million a month, it will have 12 months of runway.

A $6 million debt deal is going to provide that company an additional six months of runway. For a commercial stage company, that six months could be very meaningful as further revenue growth could drive a higher valuation at the next equity raise.

There are various development milestones where debt can play a meaningful role in helping companies reach critical inflection points in a non-dilutive fashion, such as PMA approval or 510(k) clearance. The key is to understand the value of venture debt and be clear about what it gets you without over leveraging your business. It has to buy you something meaningful. Otherwise, there is no point in doing it.

Insights Banking & Finance is brought to you by Bridge Bank