Friday, January 23, 2009

True Cost of Venture Debt Part II

First of all, I’ve gotten a lot of great feedback on the venture debt post I posted a couple of weeks ago and have had a lot of great conversations, so thank you to everyone who commented (either on my blog or via email) and keep them coming!

From these conversations and conversations I’ve had with my Bessemer colleagues, I’ve put together a presentation that discusses the venture debt analysis I described before in more detail. I’ve also included a copy of the venture debt model to this blog post so everyone can play around with the model, plug in their own numbers, and reach their own conclusions.

Venture Debt Presentation BLOG v2

If you have any troubles with the embedded powerpoint, you can also reference the pdf below:


Unknown said...

Maybe this is why many VCs are getting into the venture debt business themselves. I am not talking about providing convertible loan and/or bridge fiancing. Just straight debt with interest and warrant and no option to convert principal into equity.

Anonymous said...

Wow Sarah, this model's so comprehensive. Thanks for publishing it.

I'm not that well-versed on this subject, but I'll add one other drawback to venture debt (particularly today). All the venture debt lenders we have talked to recently are offering attractive terms in order to buy deposits. However, that can be dangerous for portfolio companies as credit markets continue to crumble. We're encouraging all our portfolio companies to diversify their cash-on-hand across multiple banks, and venture debt terms requiring company cash be kept at the lenders bank can be a real roadblock to this process.

Unknown said...

@andrew: Thanks, Andrew! Although it's a couple of weekend I'll never get back, it was actually a good process to work through the actual numbers. And agreed on your note re: minimum cash balances. It probably isn't unusual for a to company breache this covenant before they actually would have needed the money!

Zack Mansfield said...

Sarah -

Really appreciate your work on all of this. The model is fantastic and you make some strong points in your posts.

Before I go any further, full disclosure is needed: I work for a venture lender, in this case a bank (as opposed to a venture debt fund).

I agree with your analysis in the scenario used in your post - mostly because the deal described is not a good deal at all based on the assumptions. I'd go as far as to say that the venture debt as described would be the wrong decision for the company, as it's not providing any demonstrable value.

At a high level, your summarizing point is well made: venture debt is best used with companies that either a) have the cash flow to support the debt or b) there is a visible valuation inflection point as well as investment event on the horizon which justifies the cost of capital in order to get to the event. This logic is the same from the other side of the table - as a lender, I don't want to make the type of loan described unless I can see these same things.

A couple points which you mentioned in the presentation but which I will emphasize for clarity:
1) The scenario described is typical of a venture debt deal provided by a debt fund. Deals from other lenders (such as banks) are likely to be less expensive, more structured (covenants), perhaps smaller, with less emphasis on the warrant component.
2) The debt markets have changed drastically in the last 6-9 months. Finding a true venture debt deal as described above is difficult at best now and I believe more companies are choosing to go with inside equity.
3) There are still great opportunities for companies who wish to finance their working capital needs by financing their receivables base. This isn't the type of venture debt you described (as you noted in your presentation), but is sometimes lost in the shuffle when using the term venture debt. Strong companies that have top notch investors behind them can still find some growth capital venture debt, it is just much harder to come by than it was in different economic times.

Once again, thanks for the hard work in educating the market on some aspects of venture debt. I look forward to following any additional analysis in the future.

Unknown said...

Zach - Thanks so much for your very thoughtful and kind comment. You made some excellent points, and I'm glad you highlighted the points that you did. It makes the post all the richer.


Zack said...

Sarah - partially inspired by your two venture debt posts (and per our conversation at a networking event one time), finally got around to my 1st post of a series about the in's and out's of venture debt. Linking here for anyone who finds your posts...feel free to share. Thanks!