Debt can be a useful tool in building a business, as long as you don’t spread yourself too thin trying to repay the debt, says Rob Lake, senior vice president and head of Life Sciences at Bridge Bank.
“You get to a point where it becomes challenging to raise equity,” Lake says. “Now you have all this debt and you have potential equity providers who are leery of working with you because they don’t want their money to just be used to pay back debt.”
Biotech and life sciences companies are big business in today’s economy, but getting off the ground and beyond the early-stage growing pains can be a challenge.
Smart Business spoke with Lake about the consequences of being overleveraged and what you can do to get back on track toward achieving your goals.
What are some clues that your company may be overleveraged?
There are a couple clues that offer evidence that your company may have taken on too much debt.
Typically, biotech and life sciences companies will utilize a venture debt structure that includes an interest only (IO) period that ranges anywhere from 12 to 24 months. During this period, you only pay interest, not principal.
It’s an effective way to reduce the cash burn at least on a temporary basis. And it’s understandable when businesses look to prolong this period to avoid having to pay both interest and principal for just a little bit longer.
If you are struggling to find debt providers willing to refinance your loan and enable you can extend the IO period, however, that’s a sign that you may have taken on too much debt.
Another clue that you may be overleveraged is if you’re at a point where equity providers don’t want to make any additional investments until you restructure or refinance the existing loan in an effort to reset the IO period.
It’s really challenging if you find it difficult to refinance your existing debt and at the same time are unable to attract additional equity capital.
What can an overleveraged company do to turn things around?
If you want to continue to fund the business, you may have to do a very dilutive transaction, meaning you take on some equity at a lower valuation.
Existing shareholders may get diluted because you typically have the next round of equity with a new investor that will look to lower the valuation of the company.
From a lender’s perspective, right-sizing the debt is more art than science. There isn’t a formula that you can put all the numbers into and get an ironclad solution.
Yes, there are financial metrics that can be used to help determine the right amount of debt for a business, but those metrics are still based on variables and data that may not be as reliable as you would like.
As an early-stage company, it’s hard to pinpoint the true value of the company. Determining the appropriate amount of debt based on the current value of the company is not always accurate.
What’s the key to boosting optimism with your stakeholders?
You need to be collaborative and get everyone around the table to explain the situation. Have your investors reconfirm their support for your business. This will help put your lender at ease.
Talk to your debt provider about an additional IO period or a refinancing/restructuring of the loan. This will help put your investors at ease and may entice them to put in additional equity capital.
Lenders like it when a company has a collaborative attitude and is forthright with a challenging situation. Good management teams are able to coral all of the stakeholders, get everyone to work together and get the company out of a precarious situation.
Demonstrate that you have a plan and work with your investors, lenders and business partners to make it happen. ●
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