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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
3Kauffman Fellows | Venture Debt
Types Of Debt Financingd
• Venture Debt Financing• Accounts Receivable Financing• Recurring Revenue Financing• Growth Capital financing• Mezzanine Financing
4Kauffman Fellows | Venture Debt
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
5Kauffman Fellows | Venture Debt
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!)
6Kauffman Fellows | Venture Debt
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
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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?
8Kauffman Fellows | Venture Debt
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
9Kauffman Fellows | Venture Debt
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.
10Kauffman Fellows | Venture Debt
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.
11Kauffman Fellows | Venture Debt
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
12Kauffman Fellows | Venture Debt
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
13Kauffman Fellows | Venture Debt
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.
14Kauffman Fellows | Venture Debt
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
15Kauffman Fellows | Venture Debt
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.