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Bonus round: taking on some venture debt after a round of VC can give you more bang for your buck

Entrepreneur, July, 2003 by David Worrell

SILICON SEMICONDUCTOR CORP. KNOWS how to make a good thing last. The Durham, North Carolina, company makes tiny, high-efficiency power management semiconductors for use in battery-powered electronics like laptops. Late last year, the company's ability to stretch the life of a battery attracted a $10 million venture investment from the granddaddy of silicon, Fairchild Semiconductor.

That might have been enough for some companies. But Silicon Semiconductor knows that, like a battery, venture capital dollars need to last as long as possible. The company had an aggressive rollout schedule for its new technology and needed to maximize its cash available to accomplish that goal.

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With the Fairchild money in the bank, Silicon Semiconductor CEO Glenn Kline went looking for even more cash. What he found was an additional $3.2 million--part loan and part lease. The package came from the venture lending arm of RBC Centura bank, in Raleigh, North Carolina. "The trick is to find lenders who have a real venture equity perspective," says Kline, 40, "not just a traditional banker."

What Is It?

Venture debt is simply a loan that earns the lender a small pledge of stock warrants. Venture lenders are willing to work with risky, early-stage companies because that small "equity kicker" gives them a potentially large upside.

This is territory where mainstream banks fear to tread. Not only are banks scared off by the risk inherent in early-stage companies, but the law also restricts them from straying too far into equity transactions with their clients. Venture lenders, however, have the experience and manpower to evaluate and manage the risks associated with early-stage loans.

Venture debt typically follows close on the heels of a larger VC round. This helps lenders protect their downside risk: VCs have been known to help their portfolio companies make good on venture debt obligations. This kind of loan comes in two flavors: venture lending and venture leasing. If you need to grow head count, develop technology or pay rent, you're looking for operating capital from a venture lender. If, on the other hand, you need to purchase computers, real estate, heavy machinery or other assets, you may be able to get by with venture leasing.

Venture leasing typically carries a high interest rate, but the equipment you purchase becomes the loan collateral. Firms that specialize in this kind of leasing include GATX, GE Capital, Oxford Venture Finance, Pentech and Transamerica.

In contrast, venture lending typically has a very low interest rate, but you'll need to come up with your own collateral. Since young companies often have very few assets to pledge, venture lenders may take a blanket lien on receivables and intellectual property-- tactics an average bank would scoff at. On the plus side, lenders may allow you to use the loan for nearly any kind of operating expense. Leading venture lenders include RBC Centura, Comerica and Silicon Valley Bank.

Cheaper in the Long Run

Companies typically turn to venture debt soon after scoring venture capital and well before they would qualify for a standard loan. Why not simply go for more VC money? Selling company stock to a VC turns out to be one of the most expensive ways to raise capital. "The cost of equity can approach or exceed 8o percent for a successful company," says Chris Julich, manager of venture lending at RBC Centura.

Because the interest rate of venture debt is measured in single digits, many entrepreneurs choose to mix some VC dollars and some venture debt. This gives them the total capital they need at an overall price they can afford.

But don't forget that equity kicker. Remember, venture lenders are willing to manage the extra risk because they also participate in the upside gain through warrants for company stock. A $1 million venture loan, for example, can earn the lender an additional 7 percent--or $70,000--in options for stock. According to Julich, taking both the interest rate and the value of the warrants into account, the cost of venture debt comes out somewhere between 8 percent and 15 percent.

Follow the Money

Venture debt may replace a future round of equity fundraising, or you may find that it simply helps top off an equity round that fell a little short. In either case, it is almost always a fast and economical way to stretch your VC cash a little further.

How much further? "For the early-stage venture-backed company, we'll lend about 30 cents on the VC dollar," says Chris Woolley, managing director of Comerica's Technology and Life Sciences division in San Diego. Other lenders say they can add 20 to 40 percent.

If you don't have a recent VC round of cash, you probably won't qualify for the extra boost, since lenders minimize risk by lending only to highly liquid clients. Julich says RBC Centura often looks for cash deposits equivalent to more than nine months of operating expenses. Cash like that constitutes a "long runway" in venture parlance. The hope, of course, is that the business is off and flying before the money runs out.

Business Services Industry

Bonus round: taking on some venture debt after a round of VC can give you more bang for your buck

Entrepreneur, July, 2003 by David Worrell

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