Venture debt represents a growing source of funds for early-stage technology companies, one that is encouraging banks and public entities to become more involved in startup funding. Wisconsin is no exception to this trend. The state’s venture debt programs committed $8.2 million in loans in 2013, representing a substantial upside to what was a down year in Wisconsin for traditional venture capital investment. More and better deal flow, not necessarily bigger loan pools, will be key to expanded venture debt lending in 2014.
I sit on the advisory committee for the Madison Development Corp. (MDC) Venture Debt Fund, helping vet tech companies that are potential borrowers. While I have a personal and professional interest in seeing these types of programs grow and thrive in the state, I think it’s important to lay the facts out for Wisconsin entrepreneurs unaware of the venture debt option or uncertain if it holds the key to taking their companies to the next level.
“Venture debt” may sound like an oxymoron. The banking community has generally not regarded early-stage technology businesses as good credit risks. Venture debt programs work to mitigate risk to lenders through a number of techniques, including mixed pools of public and private money, specialized due diligence of technology businesses, participation with venture capital in funding rounds, and/or a preference for businesses generating revenue. Building the confidence of local banks in early-stage lending is particularly important in a state like Wisconsin that lacks specialized venture debt firms.
Chris Prestigiacomo, a portfolio manager at the State of Wisconsin Investment Board, has been involved in launching the new $30 million early-stage information technology fund, 4490 Ventures. Prestigiacomo also sits with me on the advisory board for the MDC venture debt program, so he has a perspective spanning both capital sources. “We are beginning to see venture debt become more a part of the capital structure with early-stage companies that are selling product into the marketplace. The key words here are ‘selling products into the marketplace,’” Prestigiacomo said. “While debt can be a good source of capital for companies entering a growth period, investors/managers must use some caution and feel confident the company can meet its projections to service the requirements (current cash pay) of the loan.”
Madison-based startup Murfie provides an example of how venture debt can be incorporated into larger capital structures. The company blended $1 million of investor money with $750,000 of combined venture debt from the MDC and Wisconsin Economic Development Corp. (WEDC) programs in a 2012 funding round. Murfie CEO Matt Younkle noted that his investors like the structure “because their investment is essentially multiplied with no additional dilution.”
Venture debt as part of a larger capital structure has become the norm for much of Wisconsin’s venture debt activity. This gives venture debt a significant role in leveraging current and future investment, as illustrated by statistics offered by MDC president Frank Staniszewski. The MDC program has directly loaned $10.4 million over the program’s six years. Those loans were part of funding packages that leveraged an additional $35 million in other financing at the time of the loan closings. Borrowers went on to obtain later funding rounds totaling more than $56 million, bringing the total of direct and leveraged funding to $100 million dollars in Dane County technology businesses.
This does not mean that venture debt is a good fit with every early-stage business. Entrepreneurs need to look carefully at each program’s offerings and approval process.
The first thing to remember is that these are loans that have to be repaid with interest. Venture debt programs typically offer an initial term of six months to 24 months with no payments or interest-only payments before transitioning to 36 months of principal and interest, but at some point, these loans will represent a claim on cash flow. Some companies conclude that the service obligations of a loan represent a good trade-off against selling more equity. Others look at venture debt as a backstop against a less-than-fully-subscribed round and decline the loan if all the equity falls into place.
Next, companies should research the qualifiers used by a particular program to screen applicants. Some programs may require the business to be located in a specific region of the state. Some may require a credible plan for a certain level of job creation. Some require, as noted above, that a company has entered its revenue stage.
Finally, entrepreneurs need to decide if
