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 email@example.com.
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As companies progress through their lifecycles, they have different financial needs depending on their time and position in the market. Those variables also influence what types of financial products are available to them.
To put your company in the best position to get access to credit, Larry LaCroix, senior vice president, Bridge Capital Finance Group, Bridge Bank, says that first and foremost, you need to know your business inside and out.
“It’s critical to have a well-thought-out business plan in the early stages so that you have a financial road map and metrics to track to,” he says.
Banks look at a company’s track record of financial performance and how it has corrected for any deviations from its plan. Underlying collateral that could support the loan, such as receivables, inventory, equipment and intellectual property, will also be considered. But what’s really important is the quality of management, as the key to any success is people.
Smart Business spoke with LaCroix about how companies at various stages can position themselves to benefit from bank financing.
What are the stages of a company’s lifecycle?
Companies enter the market as startups, at which point they may or may not have raised capital. They’re starting to generate revenue and have taken their business plan to market. They then begin raising money, typically through angel investors, friends and family. In this third stage, they execute their plans and gain traction in the market. They may raise Series A rounds and venture capital funds before moving into growth mode but likely still have negative cash flow. In the fourth phase, they begin to see positive cash flow as they win market share. The fifth stage is the more sustainable, in which a company goes public or possibly sell to another company. These businesses have proven they are cash flow positive and have real enterprise value.
What types of financial products are available to startups?
In the initial stage, the need for any kind of capital, whether it be equity or senior debt, is significant. Startup companies may have very little revenue but need to get their operations going. The challenge, in terms of financing, is that they’re relatively unproven.
However, there is a product that might fit a startup company that doesn’t have much capital. Invoice financing or factoring, which use a verifiably good customer and the accounts receivable as the basis for the loan, are possible options, depending on the strength of the company’s customer or the company’s accounts receivable. Banks have different ways of determining strength of these customers or accounts receivables. If it’s a public company, they look at financials. If it’s privately held, rating and credit agencies can provide information. However, if it’s an unknown company, invoice financing may not be a viable option, as the bank needs assurance that the customer will have the ability to pay back the loan.
What types of loan products are available to companies in the second phase?
Companies with decent cash positions and sophisticated investors can begin looking at asset-based lending facilities. These often contain different covenants, agreements between banks and borrowers that set benchmarks such as the ratio of tangible net worth to debt that, if broken, would result in default. Asset-based loans can be difficult to obtain at this stage because of a company’s limited history, but banks have some flexibility through the use of covenants to award these loans. And much like invoice financing, banks look at a company’s customers, which become the source of repayment and, in effect, its assets.
How can companies in the third phase get funding?
If it seems as if the company is going to turn cash flow positive, banks might start looking at growth capital lines at this stage. These lines allow a company to go to the next level and are generally in the form of a term loan.
In a negative cash flow situation, a bank will set up financial covenants because it can’t debt-service a growth capital line. Banks will then look at a company’s available cash from recent venture capital investments to cover some of that growth capital to ensure the business has enough assets in the pool with receivables, cash or future cash from investors that would allow it to satisfy the loan.
Also available at this stage is vendor acceptance, which provides letters to vendors that say the bank will pay for goods as ordered, giving the vendor ‘assurance’ it will get paid. This product is a good fit when a company is growing very fast and also works well with large spot orders for which companies need to get more credit from their suppliers.
What products are available to companies with positive cash flow to continue their growth?
Financing in this stage builds on to the existing working capital facilities but offers more term debt and acquisition financing. It’s essentially expansion capital. When a company is pre- or post-IPO, it might move itself out of the asset-based and capital finance product set and into corporate financing, where there are fewer controls and covenants. The loans mentioned previously can also be made more flexible to shape the capital structure.
Where can companies turn for help with navigating these financial products?
Brokers can help companies find the best financing, but they collect a premium for their services. The best thing is to educate yourself and, if you can afford it, find a good controller or finance executive who has experience working with banks or other debt providers. Most important, take your time evaluating your options — in particular your bank options. Get references from your referral network, friends or anyone who can offer a valuable perspective. Referrals should help a lot, especially for startup companies.
Larry LaCroix is senior vice president for Bridge Capital Finance Group, Bridge Bank. Reach him at (408) 556-8338 or firstname.lastname@example.org.
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