Venture Debt 101: key takeaways
On August 25, 2020, as part of the midwest.tech/connect 2020 programming series, we tackled the topic of venture debt and venture banking featuring panelists from Signature Bank, including Jeffrey Lampe (Managing Director, Midwest Technology Banking Group), JC Simbana (SVP Venture Capital Relationships & Healthcare Banking), and Michael Fulton (Managing Director, Venture Capital Services), hosted by moderator Julia Ruge (Associate at Sandalphon Capital).
There were 3 areas of focus: 1) types of companies suited for venture debt, 2) types of venture debt facilities, and 3) other key considerations.
Key takeaways around each focus area are included below:
Companies Suited for Venture Debt
Institutional venture backing is generally a prerequisite. Venture debt firms’ anchor point of involvement with a company is the confidence in the company’s growth path evidenced by the presence of a strong syndicate of VC investors. Debt providers at the venture stage piggyback the overwhelming majority of their due diligence from the VCs backing the company.
Venture funding should be at least $4M. Senior debt is typically provided in facility sizes ranging from $1M-$40M, but aim to provide no more than 40% of total equity funds committed to the company’s balance sheet and/or <15% of the enterprise value of a given round of investing. This best suits companies at the Series A stage or later in their growth lifecycle. Companies in some high initial capex industries (such as biotech) may need to raise $10M or more before they come onto the radar of venture debt firms.
Predictable revenue streams are best, but not mandatory. Companies with more easily forecasted revenue stream liquidity are lower risk investments and demand more favorable terms from debt providers. Some pre-revenue companies (e.g., pharmaceutical startups progressing through the phases of FDA approval) may still qualify for venture debt if they have suitable venture capital backing regardless of whether revenue is being generated or not.
Three considerations usually drive the decision to take on venture debt. Venture debt is most beneficial for companies in 3 situations: (1) companies looking to extend their cash runway by 6 months or more at the time of a venture capital Series A, B, or C financing who are able to obtain favorable terms immediately following the infusion of equity capital; waiting until the company’s cash runway runs out (a bridge round) will not position the company well in negotiations with lenders. (2) companies with an evolving business model or in need of a cushion / insurance policy on fundraising, where more than 12–18 months of cash runway would be beneficial, and (3) equity holders looking to amplify their returns via mostly non-dilutive financing before reaching a milestone-based inflection point (and much higher valuation) at the later Series B, C, or D stages.
Types of Venture Debt
Term Loan (Lines of Credit). The most common venture debt facility (especially among startups without a pure software product) takes the form of a 36–48 month facility duration immediately following a round of institutional venture capital equity fundraising. The company has a 12–18 months of interest-only payments while they determine if they wish to draw the agreed upon loan, at which point the principal of the term loan begins to be amortized over the remaining 24–36 months.
Accounts Receivable (Lines of Credit). Expect an advance rate of 80% of the company’s A/R base; be mindful that concentration risk or other factors will impact the specific terms a company is offered.
MRR Facilities. For companies with recurring revenue (such as traditional SaaS software firms) of $100k-$200k or more, a 12–18 month loan of 3x-8x MRR can be provided to further fuel growth. Rate considerations include all of the same metrics as would be considered by mid- and late-stage software or consumer investors, such as LTV/CAC, net retention rate, and churn.
Other Key Considerations
Pricing and structure will vary based on the company and the market. Pricing varies by business model and liquidity, typically 100 to 150 basis points over the Prime rate in the US Midwest. Warrants in the amount of 1–2% of the facility size (e.g., $1 million facility with $10,000 worth of warrants) are also common in the Midwest, but less commonly seen in coastal markets due to greater competitiveness of the market.
Turnaround can be quick, as additional DD is minimal. Venture debt firms rely heavily on relationships with, trust in, and the previously conducted due diligence of specific venture firms, which means that often term sheets can be presented as quickly as 24 to 48 hours after an initial discussion (typically around 7 days).
VC firms can also benefit from venture debt relationships. Commonly cited factors for VC funds making use of Lines of Credit from venture debt providers include: (1) increased efficiency getting to a close on a funding transaction, (2) communication and setting expectations with your LPs (consistent quarterly capital calls; avoiding under- or over-calling capital), and (3) enhancing IRR, though this is less relevant to VCs who have LP limitations on debt cycle length.
More information
You can check out the full webinar recording here.
More resources from Signature Bank:
If you are interested in learning more about venture debt and how it can benefit your company or fund, contact a member of Signature’s team below. They are committed to providing the expertise, flexibility and service to take your company to the next stage:
Jeff Lampe
Managing Director, Technology Banking
Signature Venture Banking Group
Chicago, IL
JLampe@signatureNY.com
Learn more about the Venture Banking Group
JC Simbana
SVP, Life Sciences + Digital Health
Signature Venture Banking Group
Menlo Park, CA
JCSimbana@signatureNY.com
Learn more about Signature Bank’s Life Sciences banking
Michael Fulton
Managing Director, Venture Capital Services
Signature Venture Banking Group
Durham, NC
MFulton@signatureNY.com
Learn more about Signature Bank’s Venture Capital Services
Summary by Andrew Hawley, MBA Associate at Sandalphon Capital.
