Venture leasing had literally created millions of dollars for Berman’s shareholders.
Craig Berman beamed noticeably after completing his board presentation. Berman,
CEO of a startup that develops nanotechnology applications for the defense industry, had just closed a $ 20 million equity round. Berman finalized the round at an equity valuation that made the whole board blush. Only six months earlier, Berman’s team faced a daunting technical delay that set the company back three months.
With only four months of cash remaining from a previous equity round, the delay would cause Berman’s company to burn cash faster and to fall short of an important benchmark.
The prospect of raising additional equity earlier than expected and at a much lower valuation than anticipated was a chilling thought for Berman and his board. Just as things appeared to be headed downhill, the company’s CFO broached the idea of obtaining $ 1.5 million in venture leasing.
Roughly $ 600,000 of this financing would be used to finance existing equipment. The balance could be used for upcoming acquisitions of computer workstations, servers, software, and test equipment.
A colleague had introduced Jamal Waitley, the company’s CFO, to Jerry Sprole. Sprole heads Connecticut-based, Leasing Technologies International, a leasing firm specializing in equipment financing for venture capital-backed startups and emerging growth companies.
It took Waitley less than a month to get the financing in place. Cash from selling and leasing back existing equipment along with a leasing line to add new equipment allowed Berman’s firm to operate three extra months without additional equity.
When the firm finally completed its $ 20 million equity round, the pre-money valuation was at least $ 5 million more than it would have been otherwise. Venture leasing had literally created millions of dollars for Berman’s shareholders.
Like Berman’s firm, a growing number of venture capital-backed startups are taking advantage of venture leasing to build equity value faster and to expand infrastructure. What is venture leasing and why has it become so attractive to venture capital-backed startups?
How are savvy entrepreneurs using venture leasing to increase shareholder value? To find answers, one must take a closer look at this important financing source for venture capital-backed startups.
The term venture leasing describes equipment financing provided by equipment leasing firms to pre-profit, early-stage companies funded by venture capital investors. Like Berman’s firm, these startups need business essentials like computers, networking equipment, software, and equipment for production and R&D.
These firms generally rely on outside investor support until they prove their business models or achieve profitability.
Where does venture leasing fit into the venture financing mix? The relatively high cost of venture capital compared to venture leasing tells the story. To compensate venture capitalists for the risk they take, they generally receive sizeable equity stakes in the companies they finance. They typically seek investment returns of at least 35% on their investments over five to seven years.
Their returns are achieved via an IPO or other sale of their equity stakes. In comparison, venture lessors seek a return in the 15% – 22% range. These transactions amortize in two to four years and are secured by the underlying equipment.
Although the risk to venture lessors is also high, venture lessors mitigate the risk by having a security interest in the leased equipment and structuring transactions that amortize.
Taking advantage of the obvious cost advantage of venture leasing over venture capital, startup companies have turned to venture leasing as a significant source of funding to support their growth and to build equity value faster.
Additional advantages to startups of venture leasing include the traditional leasing strong points — conservation of cash for working capital, management of cash flow, flexibility, management of equipment obsolescence, and serving as a supplement to other available capital.
How do venture leasing firms evaluate transactions? Venture lessors look closely at several factors. Two of the main ingredients of a successful new venture are the caliber of its management team and of its venture capital sponsors. In many cases the two groups seem to find one another. A good management team has usually demonstrated prior successes in the field in which the new venture is active.
The better venture capitalists have successful track records and direct experience with the types of companies they financed. The best VCs have industry specialization and many employ individuals with direct operating experience within the industries they finance.
After determining that the caliber of the management team and venture capitalists is high, a venture lessor looks at the startup’s business model and market potential. During this evaluation the lessor considers questions such as:
Does the business model make sense? Is the product/service necessary? Who is the targeted customer and how large is the potential market? How are products and services priced? What are the projected revenues? What are the production costs and what are the other projected expenses?
Do these projections seem reasonable? How much cash is on hand and how long will it last the startup according to the projections? When will the startup need the next equity round? These, and questions like these, help the lessor determine whether the business plan and model are reasonable
The most important question facing a leasing company financing startups is whether there is sufficient cash on hand to support the startup through a significant part of the lease term. If the venture is unable to raise additional capital and runs out of cash, the lessor stands to lose money on the transaction.
To mitigate this risk, most experienced venture lessors require that the startup have at least nine months of cash on hand before proceeding. Usually, startups approved by venture lessors have raised at least $ 5 million in venture capital and have not yet exhausted a healthy portion of this amount.
Where do startups turn to get venture leasing? Part of the infrastructure supporting startups is a handful of national leasing companies that specialize in venture leasing. Like the Connecticut-based lessor introduced to Waitley, these firms have experience and expertise in structuring, pricing, and documenting transactions, performing due diligence, and working with startup companies through their ups and downs.
Most venture lessors provide leases to startups under lines of credit so that customers can schedule multiple takedowns during the year. These lease lines typically range from as little as $200,000 to over $ 5,000,000, depending on the start-up’s need, projected growth, and the level of venture capital support. The better venture lease providers also assist customers, directly or indirectly, in identifying other resources to support their growth.
They help customers acquire equipment at better prices, arrange takeouts of existing equipment, find additional working capital funding, locate temporary CFO’s, and provide introductions to potential strategic partners— these are all value-added services the best venture lessors bring to the table.
While Craig Berman’s story is only an illustration based on actual financing, many venture capital-backed startups are discovering that venture leasing can leverage venture capital to boost shareholder value. These startups are then able to use their venture capital for growth activities that build enterprise value, like product development, bringing in management talent, and expanding their marketing efforts.
Since venture leasing is more cost-effective than venture capital, requires no board representation or loss of management control, and usually results in little or no equity dilution, this rapidly growing financing for start-ups is reaching the radar screens of many savvy entrepreneurs.
ABOUT THE AUTHOR: George Parker is a Director and Executive Vice President of Leasing Technologies International, Inc. (“LTI”). Headquartered in Wilton, CT, LTI is a leasing firm specializing nationally in equipment financing programs for emerging growth and later-stage, venture capital-backed companies.