Venture Debt financing for startups

Debt financing for Venture backed Startups

Samir KajiSenior Managing DirectorFirst Republic Bank

2Kauffman Fellows | Venture Debt

Table Of Contents

OverviewTypes Of Debt Financing

Venture Debt Overview

Recurring Revenue Lines

A/R lines

Q&A

Sources


Types Of Debt Financingd

• Venture Debt Financing• Accounts Receivable Financing• Recurring Revenue Financing• Growth Capital financing• Mezzanine Financing


Benefits And Risks Of Taking on Debt

Provide incremental runway (allowing for additional time to meet critical milestones)

Alleviate and smooth out liquidity needs due to working capital cycles

Fund growth Nominally dilutive capital (positive impact to shareholders returns)

PROS Overleveraging (can impact

fundraising efforts)− Venture debt <50% of last institutional raise;

Monthly P&I payments <15% of monthly cash burn. Under 10% is ideal

If Lender is not reputable, could be catastrophic for in a downside scenario

Preference of secured debt holders

Lack of understanding could create unintended issues.

False security

CONS


Venture Debt Overview

What is Venture Debt?Simply debt financing for Venture Capital backed companies for the purpose of extending cash runway and accelrating growth in a way that’s minimally dilutive for shareholdersA non-formula based term financing with durations of 3-5 yearsLenders provide with a belief that next round financing risk is nominal.

When is it appropriate for a company to explore Venture Debt?The company is backed by a strong syndicate of Venture partners that has the ability to further support the Company financially with or without the introduction of a new lead

For early stage companies, the management team should be able to clearly define the milestones prior to the next equity fundraising, and should have a high degree of confidence of reasonably hitting them.

The Company has a management team and board that preferably has worked with secured creditors in the past (not necessary of course!)


Venture Debt as a runway extender Venture debt as an extension of company runway

– Allows company more time to meet critical performance milestones

– Enables quick growth


Terms of Debt to be considered

Key Terms To Be Aware Of

All-in IRR: should include all fees, backend payments, etc. IRR’s range 6% - 15%+ depending on risk profile of transaction and other economics of the deal (warrants)

MAC Clauses: a subjective default that allows lender to “call” a loan if lender deems, in their sole discretion, that a material deterioration in the business has occurred

Warrants: Collateral: blanket lien on all assets is standard; IP may be included if risk level is higher

Financial Covenants: Income statement, milestone, or balance sheet.

Real runway provided by the debt?

Borrowing Base Is there a formula that governs borrowing?

Draw requirement far in advance of cash-out? If so, how amortization will there be prior to projected cash out?


Examples of Venture Debt Players

Capital source from client deposits

Cheapest but lower risk appetite Expected loss from portfolio 1-3%

BANKS Funds with 3rd Party LPs Pricier but higher risk appetite (been

through cycles)

Often partnership with value add (can provide domain and operational expertise)

Loss rate is typically higher (3-5%)

VENTURE DEBT FIRMS


Banks VS Venture Debt Firms Terms

Term Banks Venture Debt Firms

Typical Interest Rates (usually Based of off Prime Rate)

5%-7.5% 9%-13%

Upfront Fees 25bp-1% 50bps-1%

Warrant Coverage As low as 2-3%, but typically in 4%-5% range Usually 8%-12%

Draw or Interest only period 6-12 months 6-18 months

Amortization Period <=36months <=48 months

Financial Covenants Sometimes, but not typically No

MAC Clause Yes Sometimes, but typically not

Size of loan 20-40% of Recent Venture RoundDepending on the Company profile, may go up

to 100% of last round if appropriate. Usually 30-50% of Recent Venture Round.

Pre-Payment Penalty 3% Year 12% Year 21% Year 3(Can be reduced in many cases)

Same as Banks, but sometimes “Full Metal Jacket” (all future interest payments are

accelerated)

Other Conditions Company must keep primary depository and operating accounts with Bank

Deposits can be kept anywhere, although a Deposit Control Agreement document must be

executed, which provides lender a legal security interest over cash held in a bank.


Example of Venture Debt

XYZ company raises a $10MM Series A round, led by Founders Fund, done at a $30MM Pre-Money Valuation. 8M fully diluted shares authorized after round ($5/share)

Projected Burn is $500K/month (20 months of cash runway).

Company is offered $5MM Venture Debt term loan, with following terms:

–12 Month Interest only Drawdown period, following by a 36 month amortization period.

–Interest rate of 9% with back-end payment of 5%.

–No MAC

–No Financial Covenants

–Warrant Coverage of 10% on Series A shares.

• 10% * $5MM = $500,000/$5 PPS = Lender has the right to purchase 100,000 shares at $5 at any time over next 8-10 years. 100,000/8MM shares = 1.25% dilution.

Best case scenario is debt provides additional 6-8 months of cash runway, more milestones hit, and thus allowing for better valuation at B round.


Formula based Working Capital Lines (Also commonly called asset based lines)

Revolving Facilities

Typically 1-2 years in length, with ability to renew

Lender offers a borrowing base against something tangible

– AR

– PO

– Inventory

– Recurring Revenue


Formula based Working Capital Lines -Accounts Receivable Lines

Financing provided against a Company’s Accounts Receivable base, or in some cases against specific invoices (not PO financing).

Used to smooth out working capital cycles

– Good for businesses that have large AR balances. Traditional software license models, hardware models, etc.

Usually cheapest form of financing

Formula based (lender will look at quality of account debtors, concentrations). Borrowing advance rate of 70-80% of qualified eligible accounts receivables.

Almost always come with performance and/or liquidity covenants (the exception being specific invoice by invoice financing offered by some lenders).

Provided by Banks, not Venture Debt firms


Formula Based Lines - Recurring Revenue lines

Recurring Revenue linesFinancing provided against a company’s recurring revenue stream

Used to smooth out working capital and help financing CAC’s

– Good for businesses that have recurring revenue models such as SaaS and subscription based companies.

Similar pricing to Accounts Receivable lines.

Formula based on revenue

– 2-7x of MRR

– Adjusted for Churn (usually gross, but lenders becoming increasingly ok with net)

Almost always come with performance and/or liquidity covenants (the exception being specific invoice by invoice financing offered by some lenders).

– Performance to plan covenant on revenues or bookings

– Liquidity covenants (Adjusted Quick Ratio, Liquidity ratio). More common with larger deals.

– Most often provided by Bank’s, but specialty fund lenders like SaaS Capital and Golub Capital also provide.


Example of Recurring Revenue Line

ABC company is a SaaS company that has raised $20MM in Venture Capital

Investors include Emergence Capital and Social Capital.

Company currently Monthly Recurring Revenues (MRR) of $750K, and projects to end 2017 with MRR of $1.5MM. Average gross churn per month for trailing 6 months is 0.75%.

Company would like to take on non-dilutive financing to help financing growth.

Bank offers a $4MM Revolving Recurring Revenue line of credit.

Borrowing availability today = $750K (MRR) * 3 = $2.25MM

Adjustment for Gross Churn = 0.75 *12 (annualized) = 9%

Adjusted Borrowing Availability = $2.25MM * (100%-9%) = $2.04MM


Mezzanine Lines

Typically provided to companies at late expansion stages.

Often acts as last money in prior to an exit.

Offered by Banks and Funds (i.e. Silverlake, Golub)

Terms

– 3-5 year term

– Interest only through term, principal due at maturity. Interest is sometimes Payment In Kind (PIK).

– Interest rate ~11%

– With warrants, lenders aim for 15-20% return.

– No Covenants

– Shouldn’t have Cross-defaults (need to check) with other debt Company has. Mezzanine lines are often subordinate in nature to senior asset based lines.

Business

Venture Debt financing for startups