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Trust thy lender, but payheed to thine term sheetBy RONALD TRAHAN

Medical Device Daily Contributing Writer

BOSTON With venture capital reserves dry-ing up, many emerging companies are considering ven-ture debt to extend their runway to a milestone event andadditional, traditional funding. For example, ZipLineMedical (Campbell, California) just closed a $2 millionventure debt financing with Western Technology In-vestment (WTI) (Portola Valley, California).

Unlike conventional bank lending, venture debtis accessible to startups or emerging companies that donothave positive cash flows or significant assets to useas collateral. Interest rates vary widely from prime plus2% to prime plus 9%, with the loan term typically rang-ing from 24 to 48 months. A venture debt lender is alsolikely to take a lien against all of a companys assets;thus, in the event of a default, the venture debt lendercan legally take the entire company.

The venture debt deal also typically includes awarrant to buy the companys shares, usually 5% to 15%

of the loan amount. Venture debt is available mostly tocompanies that have secured at least one round of ven-ture capital financing by a recognized venture capitalfirm or syndicate of venture capital firms.

We estimate that venture debt represents about10 to 15 percent of the venture capital dollar amount in-vested in any given year, and that the known playerstotal less than 20 lenders, said Maurice Werdegar,CEO of WTI, the largest and oldest venture debt firm,which closes about 100 deals a year.

In ZipLines case, both the founder, Amir Bel-son, MD (Medical Device Daily, March 29, 2012), and

the CEO, John Tighe, have had previous successful re-lationships with Werdegar and WTI. ZipLine has devel-oped a versatile noninvasiveskin-closure technologycalled PRELOC that offers both speed and goodcosmesis, with no piercing of the skin, via a simple,easy-to-learn and easy-to-use device. ZipLine is target-ing a $4 billion worldwide market opportunity coveringmost surgical procedures involving skin incision.

According to Belson, in selecting a venture debtpartner, the most important thing is the reputation of theventure debt lender.

The company seeking the money is just look-

ing for a few more months of runway before it achievesan inflection point, Belson told Medical Device DailyBut there is always the possibility that the emergingcompany will need a little more time in reaching that inflexion point. If that happens, you dont want to beworking with a venture-lending group that is very quickin panicking, he added.

ZipLine is unusual in that Belson and Tigheboth have outstanding records of achievement thatgives lenders a high level of comfort. Prior to being re-cruited to ZipLine, Tighe was a director and presi-

dent/CEO of PEAK Surgical (Palo Alto, California)joining the company as its first employee in June 2006In July 2011, he negotiated the acquisition of Peak byMedtronic (Minneapolis). Belson was the founder oNeoGuide Systems (Los Gatos, California), acquiredby Intuitive Surgical (Sunnyvale, California) in 2009Belson is also the founder of six other companies inaddition to NeoGuide and ZipLine.

Its all about trusting your venture lender, Belson says. All the venture lenders will tell you that ifyour company gets in trouble they will be good part-ners. Of course, thats not reality.

Number one, by far, is the fine print reallymatters, says Werdegar. The horror stories aboutventure debt happen when companies sign deals inwhich the lender has certain subjectivity in how it canforeclose upon a company. In deals where the lenderhas a subjective default covenant for example, ifyour device has been turned down by the FDA at youPMA hearing is that a default or not? If youre alender, you might want it to be, because there mightstill be cash in the bank, at which point you can getyour money back. In our deals, and in many otherdeals of funds like ours, that event would not be a de-fault. We have no subjective defaults whatsoever.

I think the reason our firm is so busy, and thagreat companies like ZipLine work with us, is becausewe do not have those subjective provisions, saysWerdegar. Our best references are from companiesthat have actually defaulted with us. A great example isEmphasys Medical (Redwood City, California), whichwas turned down by the FDA for its emphysema de-vice in December 2009. They had over $10 million inthe bank, and they owed us $10 million at the time thathappened. The company eventually ran out of cash.

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We never called the default. We conducted asale effort once the board tossed us the keys, and wewere fortunate to find a buyer for the IP, which was acompany named Pulmonx (Palo Alto, California), whichhappened to also be in the emphysema space (MDD,May 18, 2009).

The short story is that its a beautiful outcome,Werdegar told MDD. By bolting the Emphasys Medicaldevice onto the Pulmonx guidance system, you nowhave an approved product in Europe that is the leadingtherapy for emphysema. Everybody felt great about theoutcome and about how the process went down. Thehorror stories about venture debt exist when companiessign deals for cheap money, at a low interest rate, withlow warrant coverage, without really understanding whatthey are signing.

Werdegar cautions companies to abide by thefollowing three rules. 1) Read the fine print. Under-stand exactly what the lenders rights are in the deal it-self. Often they dont show up in a term sheet. 2) Dont

reference-check with the successful companies butask the lender to speak with five companies that havehad problems, where theyve had to restructure theirdebt or where there was a default. Those are the refer-ences to really care about. We were the first investorsinto Facebook with equity and debt in the seed round.But the references we would give out are those wherecompanies have hit a bump in the road. NeoGuide ranout of money and couldnt pay us for seven months. Dr.Belson witnessed firsthand how we handled that. Wecreated a heat shield, if you will, protecting NeoGuidefrom other creditors. In that period of time they were ableto reconstitute themselves, eventually raised a new ven-ture round, and had a great exit when the company wasacquired by Intuitive Surgical. All parties involved wouldtell you that WTI saved the company. 3) Insist on directaccess to a decision-maker at the lending firm.

Work with someone who is on the credit committee,who has the authority to work through a problem shouldone occur. A lot of these lenders are using sales reps tosell the venture debt product, so theyre incented to getthe deal done but not to fix it if something goes wrong.

Even though we already have equity financing

in place, the venture debt is a much less dilutive form offinancing for all our shareholders. It helps us extend therunway so that ZipLine can reach additional milestonesand an increase in valuation of the company before an-other round of equity financing, adds ZipLine CEOTighe.

Some venture debt firms are better to work withthan others, Tighe continues. When I was at PEAKSurgical, WTI was very easy to work with when we hit abump in the road. If youre thinking of engaging a ven-

ture debt lender, do your homework. Check referencesTalk to other CEOs who have had supportive venturedebt relationships especially during tough times. And igoes without saying that careful legal review is neces-sary, particularly as it relates to the fine print ocovenants.

(Ronald Trahan is president of Ronald Trahan Associates Inc.which has been providing public and investor relations services to

big and small companies, private and public, since 1992. rctrahan@ronaldtrahan.com. ZipLine Medical is a client of the firm.)