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 firstname.lastname@example.org.