Barron's says the credit crunch is now hitting venture debt

At a variety of points last year, we tried to take readers through the “trickle down” impact that the credit crunch would have on a variety of industries and verticals (see prior representative posts “Credit Market turmoil and its effect on the overall Canadian economy” August 2-07 and “BNN interview on trials in the corporate credit market” July 25-07).

One of the areas of risk, at least in our view, was the venture debt lending firms that borrow capital themselves (see prior post “Next stop: Corporate Subprime?” March 25-07). In essence, specialty finance groups that lever their portfolios could be in for a rude awakening when their credit lines come up for renewal.

When we get beat on a deal over price, we generally find out later that it was either i) by the Business Development Bank of Canada (using the government’s guarantee to offer “too good to be true pricing”) or a ii) specialty lender who uses leverage to drop price by more than just a snick. Since we don’t lever our portfolio of client loans, and keep every dollar on the books (rather than sell them into a conduit), there are times when you can lose a good deal to these types of firms. If their cost of capital is lower in a particular situation, it is easier for the competing lender to drop their pricing from time to time.

Now, from the mouth of Barron’s no less, the crunch is starting to hit U.S.-based specialty lenders. In this case, the well-respected Western Technology:

“MONDAY, AUGUST 18, 2008
PLUGGED IN

Bank Woes Snag Silicon Valley
By MARK VEVERKA

THE CREDIT CRISIS HAS HIT SILICON VALLEY.

San Jose-based Western Technology Investment, a leading provider of debt financing to start-up and emerging-growth companies, is in the process of losing its $125 million line of credit.

In a federal filing late last week, WTI’s parent, Venture Lending and Leasing, disclosed that the investment company was unable to reach new terms with its lenders, JPMorgan Chase and Deutsche Bank, which are pulling the credit line. WTI will have access to less than half its original credit facility until Sept. 30 when it expires entirely.

“This is an example of where Wall Street is hitting Main Street in a big way,” WTI Chief Executive Ron Swenson told Barron’s.

“We are not in default and never have been in our 30-year history,” Swenson says. The CEO says that WTI’s portfolio companies are doing fine and that his firm has “very strong capital investors.” It’s simply a matter of the banks wanting to get rid of certain securitized debt from their books, he says. WTI’s credit line was likely bundled and re-packaged in a special investment vehicle, financings that are under intense scrutiny and revised accounting rules. “All the banks are doing is trying to get more liquidity,” Swenson says.

The credit line provided low-cost capital to WTI, which was able to pass that liquidity along to Silicon Valley start-ups. Now, WTI will have to obtain a new credit line in a more traditional form at higher rates, Swenson says. Not an unfamiliar story these days, but new to the relatively low-profile niche of emerging growth debt-financing.

WTI’s client roster reads like a who’s who of Silicon Valley venture-capital firms. One of its larger clients is DCM Capital of Palo Alto. “This is the first I’ve heard of it, but I have nothing but good things to say about Western Technology Investment,” says DCM Capital founder Dixon Doll.

DCM-backed start-ups have used the investment company more than a dozen times, including to secure loans for Neutral Tandem (ticker: TNDM), a Chicago telecom that I wrote about (Plugged In; June 5, 2006) and that went public in November 2007. WTI has provided financing to more than 100 start-ups, according to the filing, in a broad array of emerging growth areas from biotech to telecom to software. Venture capitalists often direct their portfolio companies to borrow money from outfits like Western Technology Investment, or rivals like Silicon Valley Bank Financial Group, to augment their balance sheets. The credit lines offer flexibility, and the lenders tend to understand the particular needs and demands of tech start-ups and structure the deals accordingly.

While Doll says he was unaware of any problems at WTI, he was equally unaware of any pressure from major creditors toward other tech lenders. “We haven’t seen anything like this from their competitors,” Doll says.”

I don’t doubt that Western Tech will work it out, but their experience is a good reminder to all borrowers to do your own due diligence on your capital provider. How are they funded? Is their capital committed? Are they backed by a hedge fund, who might need the capital a few months from now should a more rosy investment opportunity appear.

If the money that your lender is lending you comes from a bank operating line or some other facility, the credit crunch can make it’s way into your life whether you like it or not.

MRM
(hat tip – CN)