Going Into Hock
No sales? No collateral? No problem. Raising debt has never been easier for
small companies.
By Luisa Kroll, Forbes magazine, 1 November 1999.
© Copyright 1999, Forbes.com
----------------------------
Even the most promising young companies, on the road to going public, have
to slip their hands into someone else's pockets. Venture capitalists have
invested a record $12 billion in the first six months of this year. But they
aren't the only piggy bank in town. These days, everybody wants a piece of a
hot enterprise. Banks used to be as eager to lend to brand-new companies as
to professional gamblers. Now lenders of every stripe--commercial
institutions, bridge-loan outfits, venture leasing firms--are falling all
over themselves to hand out cash to profit-challenged companies, provided
they have venture capital backing. Loan originations to venture-backed
companies doubled between 1997 and 1998, to $4.2 billion last year, reports
research firm VentureOne.
Going into hock greatly increases the risk that a company will fail. But it
makes perfect sense to entrepreneurs who really believe in themselves. If
you're sitting on the next Amazon.com, you don't want to be giving away
equity. "Any share you give up today may be worth more tomorrow," says
Didier Moretti, chief executive of Annuncio Software, a Mountain View,
Calif. firm that automates Web marketing. In the past, Moretti, a veteran of
three other entrepreneurial ventures, would raise one large venture round,
never knowing when he'd need capital. Now, since he can borrow money if he
ever runs low, he can raise several smaller rounds and avoid giving up too
much ownership too soon. Chipshot.com, a golf e-commerce company, could
have resorted to equity funding when it was running low on cash last winter,
but it wanted to delay another round for 60 days--to let a national ad
campaign soak in and to hire key employees. It took out a $5 million loan,
brought on a top executive and tripled sales in two months. By the time it
raised another venture round ten weeks later, Chipshot's valuation was 30%
higher.
The lenders are getting more flexible. Used to be that a company borrowing
to cover payroll or an inventory buildup would get a 12-month bank loan
backed by tangible assets. Today some banks, especially those out in Silicon
Valley, may be willing to lend against intangibles like a patent or an idea
backed by a leading venture capitalist. But woe betide the deadbeat. Banks
will seize such virtual assets in case of a default, or renegotiate the
terms of a loan if a company misses a launch date, a sales target or an
expected follow-on round of venture capital. Loans of this sort can go as
high as 25% of whatever amount was raised in the most recent equity
infusion.
A common form of debt financing is a capital lease, in which the bank pays
for, say, a fleet of trucks or a stack of servers, then leases the equipment
to the user. Base interest on these loans can be below prime. Watch out for
"other lease components" that can jack up costs. Miss payments and the repo
man shows up.
A new twist on an old sort of loan is known as venture debt--basically,
subordinated debt with an equity kicker. Because these loans aren't
secured--indeed, get repaid only after secured creditors are satisfied--the
lender is going to demand several points over prime plus equity or warrants.
Highly regulated banks don't provide such loans; leasing firms and insurance
companies are more willing to take on the risk.
Most heart-arresting are bridge loans, which carry a company to an imminent
financing event--a venture round, an initial public offering or an
acquisition. Expect to pay with warrants and interest rates two to four
percentage points above prime. Traditionally, you'd have only 60 days to
repay the loan; now it's stretching out to 120 days in some cases. Lenders
are particularly willing to stretch their rules in a bull market. Don't be
surprised if they disappear as quickly as they emerged if the economy turns
sour.