Funding Column

 

When Does Your Venture Warrant Debt?

 

By Jeff Roberts

 

An early stage company is constantly under pressure to find its next source of capital — whether it be to fuel innovation or to expand its sales and marketing efforts. There are now many forms of debt available to the early stage company, which is generally referred to as "venture debt," and this evolution in lending has taken hold in Utah. Commercial banks and traditional leasing companies have long played a role in the development of Utah's emerging market economy. Now there is a strong emergence of venture lenders, drafting off of the growing equity interest in the region, which may cause early and middle stage companies to ask, "When is debt appropriate and what are the costs?"

The founding premise in a lending relationship is that borrowed money is to be repaid. It is up to each lender to determine which source(s) of repayment fits within its risk parameters. Traditional lenders (commercial banks and leasing companies) have historically utilized operating cash flow and liquidation to evaluate the prospects of repayment. Venture lending introduces a new concept — investor support. Deep-pocketed or relationship-driven investors with material investment in a project are viable sources of further capitalization, and may represent an alternative source of repayment. Due to the intangible nature of the relationship between the investor and the lender, it is impossible to clearly define the "perfect fit," but borrowers should recognize the option exists in today's lending market. But is debt the appropriate vehicle?

When evaluating venture-lending options, a borrower should consider factors that go beyond simple economics. Debt offers a company a way to reduce its cost of capital. Similar to equity investors requiring mechanisms such as BOD representation or control provisions, a lender requires demonstration of a company's financial health through reporting requirements and operational milestones. Other important considerations include how a lender's structure (i.e., covenants) can dictate strategy. While it may not be in the long-term best interest of a company to abstain from investment in NPV positive project(s), it may be necessary when strictly abiding by a loan agreement. This scenario represents a potential cost when utilizing other peoples' money, and illustrates an important cost consideration (both hard dollar and opportunity) before obtaining debt.

In addition to the cost-benefit of debt, it should be noted that factors surrounding debt can be viewed as a positive for a company in its formative stages. The compulsory discipline and accountability inherent in a lending relationship creates an environment where all stakeholders understand a company's objectives, and pull in the same direction. This acts to moderate the distraction of non-core opportunities that can plague companies at vulnerable times, and keep a management team focused on maximizing the company's core competencies.

There are some very compelling reasons why a lending relationship makes sense, and now, more than ever, viable debt options exist for companies of all stages in the region. It is a strong sign to see increased interest in Utah's early stage business environment. Companies should fully consider their options regarding capitalization in order to fully derive the most benefit from this trend.

 

Jeff Roberts is a senior vice president of the Technology and Life Science Division of Comerica Bank. He has covered the greater Salt Lake region for the last five years where the bank has committed over $125 million to early stage businesses in the area. Contact him at jdroberts@comerica.com or 425-452-2529.

 

Launch - Summer 2008

 

 

For the full "digital magazine" version of Spring 2008, visit: www.nxtbook.com/nxtbooks/growutah/launch_2008summer/