What is venture lending?

When is the best time to put a credit facility in place?

Why should I avoid financial covenants in my credit facility?

Why should I avoid MAC default clauses in my loan documents?

What is growth capital?

How are loans secured?

What is important to know about blanket liens and liens on intellectual property (IP)?

Why is a lender’s funding capacity important?

Q: What is venture lending?

A: Venture lending is a complement to venture capital where companies can establish lines of credit and borrow money even though they would not otherwise be creditworthy from a traditional banking perspective. Startup companies use debt to leverage the equity they have raised, enabling the equity to last longer and be used more productively. Debt is considerably cheaper than equity from a shareholder dilution perspective and by financing certain expenditures, companies can save their expensive equity dollars for other uses. Many companies use credit lines to finance their capital equipment expenditures, software purchases, as well as soft costs like tenant improvements, mask sets, and tooling. Companies may also borrow funds for general corporate purposes. Typically companies can establish credit lines for as much as 30% to 40% of the equity that have raised. .

Q: When is the best time to put a credit facility in place?

A: It is best to put a credit facility in place in conjunction with closing a round of equity financing or shortly thereafter, when the company has cash. Thus it is important to think about how you want to incorporate debt in your capital structure as you are considering the parameters of your equity financing. In this way you can look at your company’s capital structure as a whole, determining how much capital you require immediately and over time, and the combination of equity and debt that you will use to fulfill those requirements with minimal dilution.

It is often possible to establish a line of credit well after your equity round has closed if the company still has a reasonable amount of runway before it runs out of cash.

Q: Why should I avoid financial covenants in my credit facility?

A: Covenants are restrictions under which a company must operate in order to borrow money or keep an outstanding loan balance. They may require a company to maintain minimum cash levels, meet certain financial ratios, raise equity by a specific date, or meet other financial tests.

The existence of covenants can impact the operations of the company because management must operate the business to remain in compliance with the covenants.

Covenants can also severely restrict the usefulness of a credit facility. For example, if a covenant requires the borrower to maintain a minimum cash balance of $2 million at all times, the borrower’s $3 million credit facility really provides only $1 million in usable incremental cash.

Finally, violating a covenant can cause a default on the loans. At best this means that the borrower and lender must restructure the credit facility and design new covenants. At worst, it can result in the lender calling the loan and making the entire outstanding balance due immediately. This can have a significant negative impact on a company.

Because of (1) the restrictions covenants place on managing a company’s operations, (2) the way covenants restrict the usefulness of a credit facility, and (3) the added risk of a covenant violation and loan default, it is best for a borrower to avoid financial covenants.

Q: Why should I avoid MAC default clauses in my loan documents ?

A: Lenders often include a Material Adverse Change (MAC) default clause in their loan agreements. This gives the lender the ability to call a default under a broad set of circumstances which can be very subjective. For example, if a key member of management leaves, if the company misses its revenue plan, or if the company is struggling to raise capital, the lender can deem these to be “material” adverse changes and force repayment of the loan. This can put a company in jeopardy at critical times. MAC default clauses are not usually mentioned in the term sheet, so it is prudent for borrowers to ask specifically about MAC default when negotiating the term sheet and avoid them whenever possible.

Q: What is growth capital ?

A: Growth capital is a much more flexible type of financing than credit lines for equipment and soft cost purchases. The dollars borrowed under a growth capital line of credit can be used for any corporate purposes. There are no requirements to provide invoices or other backup material when borrowing under this type of facility, so administration is simplified as well.

Growth capital is a good way to extend a company’s runway between rounds of financing. The extra time can be used to complete additional milestones that will raise the company’s valuation, or as insurance to ensure that all intended milestones are successfully accomplished.

Q: How are loans secured ?

A: Lenders take a security interest on certain assets of the company when they provide financing. In general these security interests fall into two categories: (1) liens on the specific assets financed, and (2) liens on all assets of the company (blanket liens). Specific asset liens are common for capital equipment financing lines where borrowers seek to finance as much as $5 million. All-asset liens are common for larger capital equipment financing lines, lines that finance a significant amount of software or other soft costs, or growth capital lines of credit. All-asset lines typically include liens on a company’s intellectual property.

Q: What is important to know about blanket liens and liens on intellectual property (IP)?

A: Loans for capital equipment are typically secured by a lien against the specific assets financed. Other loans, including loans to finance a significant amount of soft costs, or loans for growth capital where the dollars for any corporate purposes, are often are secured by broader liens, including all-asset (blanket) liens and liens on intellectual property.

In a liquidation or winding down of a company, a broader lien puts the lender who holds that lien ahead of unsecured creditors of the company, so the lender is paid in full before the unsecured creditors receive any proceeds from the liquidation. All creditors, including unsecured creditors, are always paid in full before equity holders receive any proceeds. Thus the blanket lien or lien on IP changes the priority among a company’s creditors, but not between the company’s creditors and equity investors. Receiving a blanket lien or lien on IP enables the lender to provide more flexible deal structures and more dollars because the lender’s collateral is better.

 Because a company can give a first priority lien on all assets and IP to only one lender or syndicate, borrowers should ensure the lender to whom they give this lien has the dollar capacity to support them through multiple rounds of financing. Otherwise, the borrower may have to replace the original lender with another lender later. Doing so will cause the borrower to pay warrants a second time, an unnecessary cost.

Liens on intellectual property can be structured so they do not affect a borrower’s ability to license its technology, and the company and its investors maintain complete control of the intellectual property.

A: In today’s environment, a company’s path to liquidity is longer. The company will go through several rounds of equity financing before reaching an exit, and will likely want to leverage each of its equity rounds with debt to make its capital last longer. When selecting a venture lending partner, it is especially important to know the amount of financing that that partner is able to provide. This will ensure that the partner will be able to support you both now and in the future. Ask the lender how much financing they can provide your company both in the current transaction and over time. Can they provide this financing from funds currently under management, or do they need to raise additional capital or syndicate the transaction with other lenders? Ask for examples of the largest transactions that the lender has done.