A software company’s primary cost is people. They don’t necessarily need to purchase equipment, furniture or fixtures. They need engineers and money to pay salaries.
“That’s going to be very different from a non-tech manufacturing company that needs big pieces of equipment to make their widget,” says Mike Lederman, senior vice president and regional market manager with Bridge Bank.
This means the types of loan products needed by technology companies are going to be unique to that industry.
“Look for a banking partner that is going to understand your business and not just look at the numbers,” he says.
Smart Business spoke with Lederman about the financing options for technology companies through the stages of their life cycle and how a company can surround itself with a strong support network.
What loan products are available to pre-profit/venture-backed startup technology companies?
Starting from early stage to more mature venture-backed startup companies, step one may be an invoice financing facility where a lender is financing individual invoices. Also consider a revolving asset-based line of credit, which uses accounts receivable to establish a borrowing base instead of specific invoices.
Next would be a general accounts receivable line of credit, which is structured much like an asset-based line but with fewer lender controls based on a company’s stronger balance sheet. Banks also could add a non-formula line of credit that you draw on and pay interest on the outstanding amount, much like a home equity line of credit.
On the term debt side, banks offer growth capital term loans, which come with financial covenants. This structure may include a six-month, interest-only period followed by 30 months of equal principal payments plus interest.
Also available are equipment term loans, structured very similarly to growth capital loans, but instead of funding the money up front the bank would finance the equipment a company purchases. The bank is looking more at the equipment purchase price to structure the availability.
Banks also offer a venture term loan, which is similar to a growth capital loan but without financial covenants. That’s a good fit for a company that has raised equity capital within the last year and wants to extend runway between equity rounds, in order to increase valuation for the next equity round.
Finally, bridge loans are a great way to help with working capital shortfalls prior to a defined liquidity event, typically an equity round.
What particular needs might a tech startup have that differs from startups in other industries?
A lot of Software As a Service companies will be the host for the software they deploy to their customers, so buying or renting space on servers is a big expense as their customer base grows and uses more bandwidth.
Where banks can help is with working capital shortfalls, meaning you’re past the development stage and you’re actually selling your products, but you have to pay your suppliers before your customer is paying you. You might have to pay at net 30 and you’re getting paid at net 90; that’s where a bank can add tremendous value with short-term working capital until you can collect from your customers.
How and why do loan structures change as a company evolves throughout its life cycle?
As a company matures, it has additional needs. On day one it might have only a few customer invoices, but as a company grows it gains new customers each comprising 10 to 40 percent of total accounts receivable. Now the company can qualify for a more traditional line of credit. Once revenues increase or an equity round closes, a company can consider growth capital or venture debt to support long-term working capital needs as opposed to the short-term line of credit used to pay vendors before receiving customer payments.
What should a technology startup look for in a banking partner?
Numbers are important, but understanding the particular needs of the company is what differentiates a bank from its competitors. Avoid working with a bank that is only interested in your investors. Venture capital investors are an integral part of how banks underwrite credit, but it shouldn’t be the reason they do the deal.
Also, work with the same relationship manager at the bank throughout your life cycle — from the time you open your first checking account to an IPO — because he or she is going to know your history. Continuity is key to a successful relationship, and working with a bank that allows that is important.
Should the entrepreneur expect to provide the bank with a personal guarantee?
Not if it has received equity capital from an institutional investor. If a company hasn’t attracted institutional equity capital and hasn’t been able to sustain positive cash flow, a personal guarantee may be required. Banks need to understand there is someone willing to stand behind the company. The guarantor is responsible for the loan, but the bank’s expectation is there are other company assets to help repay the bank in a liquidation scenario.
How can service providers help you?
It’s important for an entrepreneur to be surrounded by a network that can provide service and support so he or she can focus on building the business. Get an attorney, bank and CPA that do a lot of work with technology startups. They can help with introductions, advice or serve as a sounding board. Focus on building the business and use your network of service providers to bring in partners. Attorneys and CPAs are phenomenal referral sources for banks and vice versa because entrepreneurs realize this is important to keep in mind as they grow their business.
Mike Lederman is senior vice president and regional market manager with Bridge Bank. Reach him at (415) 230-4834 or firstname.lastname@example.org.
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