10 States down, 40 more to go

Dateline: San Francisco

So much to do, so little time.

I just spent a couple of days on the West Coast. It was a chance to connect with entrepreneurs, a couple of our Fund IV portfolio companies, advisors and a handful of our venture capital partners. Wellington’s now in its fourth year of doing U.S. transactions, and we still feel like we are only just scratching the surface. With 3,500 VC fundings each year, it would take a small army to meet everyone. Conferences make it easier, as the oddities of the real estate market mean there are hubs in Palo Alto, San Francisco, Santa Clara, Redwood City, Danville, San Jose…. Lots of driving.

The feedback from this trip was telling. We’ve won enough good U.S. transactions now that people are calling without prompting, and referring us into situations now merely by reputation, plus what naturally flows from the regular stream of press releases with high quality companies and VC sponsors. On one VC-backed opportunity last week, the CEO told us that our firm had been suggested to him by three different parties as a good source for venture debt. Two of the kind folks who spoke well of us were people we’d never met. Gracie! As much as you’d like to think it’s a popularity contest, the thing that is working best for us is our True Growth Capital product: debt that doesn’t amortize.

For about 30 years (pre 2000), tech companies had two debt options. A bank line backed by cash and receivables, or an amortizing venture debt loan that acted just like a mortgage on your house. You had to pay some of the principal back each month. Historically, venture debt firms would try to give companies a 6 or 9 month holiday on those principal payments, but eventually those payments had to start…and start with a vengance.

When we started the firm back in 2000, it didn’t make much sense to be a “me too” debt provider. Our analysis was simple: if the “Old Economy” can borrow on a non-amortizing term loan basis to build a plant, then why can’t the “New Economy” raise term debt to grow, too? For the tech CFO who runs the numbers, they quickly realize that to have the same amount of venture debt capital under a traditional amortizing debt structure (even with some sort of principal holiday) as our term facility, he/she needs to borrow about 50% more from the amortizing folks just to have the same amount of funding two years out as they’d get from our product.

That’s expensive!

By nature, our product lends itself to a mid-stage type of company. We’ve always wanted to see at least $5 million of trailing revenue. There are definitely some debt folks who lend against a business plan post the Series A round, or perhaps an early version of product that VCs have financed. Those loans always seemed to be predicated on the VC syndicate doing a follow-on round at some point in the not-to-distant-future, where the credit analysis is solely based upon the VC brands in question, how much capital they have reserved for follow-ons, and stuff that has nothing to do with the actual business that is borrowing the capital in question.

We’ve always cared about the prospects of the business, which is why revenues and customers are so important. The fact that we can pass on a deal ’cause it’s too early for us, but do it 6, 12 or 24 months later speaks to the clarity that entrepreneurs have about our business model. When we say “not now”, it’s really a function of the company’s capacity to draw term debt on that given day. It’s not a negative statement about the quality of the management team, the “space” they’re playing in or the viability of the forecasts. Particularly when there’s already some debt on the balance sheet from a bank; each company has a finite debt capacity, and it isn’t good for anyone, management, staff, VC, customer or lender to go overboard on that front.

Now that we’ve closed more than 20 U.S. transactions of that form, and recently raised our $190 million 4th fund, folks are starting to notice. One Palo Alto-based VC said that our arrival was changing the marketplace, as the amortizing guys were being forced to push out their principal holidays beyond their long-standing traditional metrics. That’s good and bad, of course.

Some firms aren’t able to respond to this new competitive dynamic, as they themseles have levered-up their own equity with a wharehouse line from a bank; perhaps 2 to 1. The bank in behind the debt fund wants to see those individual monthly principal payments as a proxy on the financial health of the portfolio. The idea that they’d provide a 36 month principal holiday is anathema to folks who saw venture debt as a feat of balance sheet engineering, rather than what it really should be: an assessment of Enterprise Value and the prospects of the innovation business in question.

Other debt firms are stepping up, and its good for the industry as a whole. Prudent financial structures are the hallmark of a successful industry, and bringing stable capital to the plate is something we very much enjoy. We just closed our first deal in the City of Philadelphia earlier today, which represents a deal in ten different U.S. States, all told.

Looking so much to doing business in the other 40.

MRM