Debt Financing Alternatives for Todays Bioscience Company

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Debt Financing Alternatives for Todays
Bioscience Company
February 16, 2005
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Agenda

• Definition What It Is What It Is Used For
• Ascertaining Its Value Is Debt Worth It?
• Types of Financing, Typical Terms, Availability
• Separating Myth From Reality
• Some Gotchas How To Avoid Them
• Choosing a Provider Managing the Relationship

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What Is Senior / Venture Debt?

• Historical Definition Venture Leasing
• Todays Definition Any form of debt financing
  provided to a company that is still dependent on
  venture capital financing to fund its operations
• Not just term debt anymore may include revolving
  working capital financing

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Typical Uses of Venture Debt

• Literally speaking
• Financing Equipment
• General Corporate Purposes (Financing Anything)
• Financing Revenue Growth
• The Real Value Proposition Leveraging equity
  capital in order to increase valuations between
  equity rounds, reduce dilution, and enhance
  investor return
• Tangential Benefits
• Enhances appearance of financial stability and
  staying power for prospective/existing
  customers
• Unlock restricted cash (landlord security
  deposits, etc.)

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Ascertaining its Value Is Debt Worth It?

• For companies at all stages of development, the
  answer is yes but conflicting viewpoints
  abound!
• Current Attitudes About Debt
• Were borrowing our own cash it doesnt add
  runway
• Too expensive / warrants coverage too high
• Gets repaid too quickly to help with
  dilution/investor IRR
• Doesnt make sense for pre-revenue companies
• Makes sense for pre-revenue companies, but only
  in modest amounts
• Makes sense for pre-revenue companies, but only
  in gigantic amounts (more than 6 months cash
  burn)
• Makes sense for revenue-stage companies that need
  to finance sales growth and/or enhance
  credibility with existing and prospective
  customers

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Defining the Value Proposition for Venture Debt

• How much debt and for what purpose?
• What is the potential impact on dilution?
• What are the other considerations?
• Are we being realistic?

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Defining the Value Proposition for Venture Debt

• The Bottom Line If the amount, purpose, and
  cost/benefit analysis are making sense to you and
  your board, and so long as your expectations
  regarding the above are realistic, its time to
  proceed!

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Types of Financing Venture Term Debt

• Advances for new and used equipment purchases, to
  include some portion for soft costs
• Draw periods of 0-12 months, followed by
  repayment periods of 36 months (may be longer for
  lab / test equipment)
• May sometimes include an interest-only period
• May sometimes include a lower stream rate w/final
  payment
• May be specific lien on equipment financed or
  first priority blanket lien on all assets (may
  exclude IP)
• May or may not be governed by financial covenants
• Pricing a function of debt terms and risk profile
  of company
• Available to companies that have raised Series A
  and later, from both bank and non-bank providers

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Types of Financing Growth Capital

• Advances for anything no invoices required
• Draw periods, repayment periods, interest-only
  periods, etc. are similar to equipment loans
• First priority blanket lien on all assets (may
  exclude IP, but less frequently than equipment
  loans)
• Typically no financial covenants
• Pricing a function of debt terms and risk profile
  of company pricier than equipment loans
• Available to Series A and B companies, from
  select bank and non-bank providers availability
  declines for companies at later stages of
  development

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Types of Financing Working Capital

• Advances against eligible A/R other formula
  options can include advances against inventory,
  purchase orders, recurring revenue, contractual
  payments, etc.
• Generally revolving for a term of 12 months
  payments of interest only with principal upon
  maturity (renewable annually) may include other
  costs
• First priority blanket lien on all assets (may
  exclude IP depending upon nature of IP)
• May or may not be governed by financial
  covenants, with pricing and degree of control
  over collateral proceeds as the typical
  trade-offs
• Pricing a function of debt terms and risk profile
  of company
• Available to revenue-stage companies, from select
  bank and non-bank providers (i.e., asset-based
  lenders)

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Separating Myth From Reality

• The Myth Eliminating covenants and/or the MAC
  clause will result in cheap equity
• The Reality
• Debt is always debt, and can exit under certain
  circumstances pay attention to other provisions
  like insolvency clause, management rights, etc.
• Covenants can be a good thing usually less
  expensive, results in less ambiguity over what
  constitutes an Event of Default

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Separating Myth From Reality

• The Myth Growth Capital is the most valuable
  form of venture debt
• The Reality
• Only if it doesnt block access to cheaper,
  interest-only forms of working capital financing
  upon reaching revenue stage
• Pay attention to repayment terms v. timing/amount
  of expected valuation increase

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Separating Myth From Reality

• The Myth Pledging the IP is Inappropriate
• The Reality
• Can be key to obtaining the greatest amount of
  debt on the most favorable terms
• May be essential in order for lender to perfect
  its lien on A/R and inventory
• Will not get in the way of maximizing the value
  of the IP
• May allow management and investors to preserve IP
  in a bankruptcy scenario
• Doesnt really give the lender any leverage they
  dont already have it just feels that way

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Some Gotchas How To Avoid Them

• The Gotcha Growth Capital v. Working Capital
  The Unforeseen Trade-Off
• With one exception, a big slug of term debt today
  may preclude you from obtaining cheap,
  interest-only working capital financing upon
  reaching revenue stage
• Avoiding the Gotcha
• Choose a debt provider that offers the whole
  spectrum of debt financing solutions for
  companies at all stages of development
• Negotiate a real carve-out for future working
  capital financing

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Some Gotchas How To Avoid Them

• The Gotcha Big Debt is Better!
• Avoiding the Gotcha
• Yes if things go really, really well, however.
• Large amounts of debt can be an impediment to
  future equity rounds
• Smaller amounts of debt, to the extent that debt
  service places a lower burden on cash burn, may
  add more value than larger amounts of debt
• Ensuring that debt service is no more than 10 of
  cash burn in the early stages is prudent
• The larger the amount of debt, the more the
  choice of debt provider matters

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Some Gotchas How To Avoid Them

• The Gotcha Financial Covenant Misperceptions
• Avoiding the Gotcha
• Deals with covenants are often cheaper, but may
  not add runway in certain instances
• With a few exceptions, no-covenant deals will
  become more scarce as the company progresses into
  revenue stage and beyond
• Covenants can largely eliminate the ambiguity
  associated with the MAC clause, often with more
  favorable terms
• Where appropriate, ask your lender for covenant
  and no-covenant options so as to better
  understand the trade-offs relative to the
  intended purpose

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Some Gotchas How To Avoid Them

• The Gotcha Not Understanding What Your Board
  Wants
• Avoiding the Gotcha
• Your board members have a perspective on debt
  and hot buttons abound!
• Reach a clear agreement as to the type of debt,
  who should provide it, what the terms should look
  like, and how the value proposition will be
  defined prior to soliciting proposals

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Choosing a Debt Provider

• Things to Consider
• How are credit decisions made?
• What is their typical deal size/type?
• How much do they have available to lend?
• Transactional or relationship oriented?
• How is their reputation?
• Are they in trouble?
• Do Your Due Diligence
• Get references, and actually call them!
• Check with your board, other service providers,
  and former/current borrowers
• Review financials, press releases, etc. if
  applicable

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Managing the Relationship

• Meet with your lender regularly provide updates
  as to how the company is doing, what the board is
  thinking, etc. treat them like a partner
• Provide all required financial and collateral
  reporting in a timely manner
• Avoid surprises
• Communicate, Communicate, Communicate!