In this twenty-first century phenomena of cheap money, interest rates have never been this low for such a long period of time. American business has been sitting on cash with some estimates placing the amount at $1.8 trillion. But now, with continued signals of U.S. economic improvement, investments by businesses are now forecast to reach a record $1.5 trillion in 2015 (1). Combine low interest rates with a growing number of increasingly confident small- to medium-sized businesses focused on making equipment improvements and the result: more capital moving to specialized niches of the debt capital space.
Venture debt lending has often been associated with outsized current pay interest rates not pegged to commercial bank pricing indexes (i.e. Prime rate or LIBOR). Very simply, banks and investors continue to seek out more yield and to do so, are willing to accept more risk. This scenario is typical of a prolonged, improving economy combined with consistently low levels of loan defaults. Lenders tend to have short memories when stakeholders and stock analysts are putting pressure to accumulate strong earning loan assets.
In the venture capital area, investments have grown from some $23 billion invested in 2010 to $48 billion in 2014, with the number of deals increasing from 3,800 to 4,400. (2) The last four years of venture capital investment have seen 73% of the capital go to early stage and expansion stage. To protect the investors in these rounds, venture debt/leasing helps these companies get access to more capital “around the fringes” as they get revenue traction, scale products & services, and have cash flow to potentially start servicing the debt rather than needing to raise more capital to pay down their obligations. By being the first institutional lender to a VC backed portfolio company, venture lenders can take senior secured collateral interests in all of the company’s assets (even IP if permitted) and combine this risk mitigation with attractive double digit interest rates and most times a small equity warrant in the business.
Venture debt/leasing helps move the business from early to expansion or expansion to a major event (IPO or change of control). The lender’s injection of additional liquidity for financing of fixed assets further propels the business in revenue growth, at times improves profitability and can enhance valuations for the next capital raise or positioning for the major event.
The aggressive run up of the public equity markets the past couple of years has provided VC’s and their lenders exits and liquidity that had not been available between 2007 to 2012. In a 20-year period of 1994 – 2014 saw VC hold periods almost double -- five to eight years. In 1994, it took an average five years for a company to IPO; in 2004 it took six, and in 2014, the average crawled up to eight. VC backed businesses have been required to pivot from the “grow to an exit” to more “grow and demonstrate profitability to an exit.” The nuance of typically needing to introduce new management and generate positive cash flow have essentially doubled the hold time that VCs need before realizing their investments and at the same time provided investment bankers the required financial fundamentals for underwriting a more attractive IPO. The exception is the sighting of the Silicon Valley Unicorn.
Where $1 Billion is the New Million
Welcome to the age of the “Silicon Valley Unicorn.” In a November 2013 TechCrunch blog post, Cowboy Ventures founder Aileen Lee coined the term for billion-dollar start-ups -- fast-flying high tech companies with large accumulations of stock and cash, billion dollar valuations and a glut of private capital. Big data, cloud, enterprise, e-commerce, mobile, media and social networking … these are the arenas in which Unicorns are spawned.
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