David Spreng, the founder and CEO of Runway Growth Capital and the author of All Money Is Not Created Equal, is a seasoned venture and growth debt lender with 30 years of expertise.
A brief phone contact with a potential lender that involves an equal amount of selling and listening on both sides serves as the initial step in the process of raising venture debt.
Imagine it as a first date. If everything goes well with that, an NDA should be swiftly signed by both sides. (VCs dislike signing NDAs, but venture debt lenders are fine with it.)
We would then begin our initial due diligence at this point. Normally, we ask a corporation for six things:
a presentation for investors
You most likely just raised equity if you’re searching for investment capital. You could utilize the same investor deck for venture debt that you would have for that. (The internet is full with examples.)
The annual evaluation of the equity worth of the business, intended to safeguard employees who receive stock options and prevent them from subsequently being hit with a tax for obtaining “cheap stock.” Most of the time, those valuations are at a point where receiving equity is appealing to employees. If the 409A valuation company’s value estimate is less than what you consider to be reasonable, don’t be concerned. We are aware of how these appraisals operate and avoid being preoccupied with them.
The 409A will include several methods of evaluating the company’s valuation that we also consider, such as discounted future cash flow, comparables to publicly traded companies, and comparables to recent M&A. It will also provide a thorough history of all the financial support the business has ever received, and it always includes a five-year estimate.
A thorough capitalization chart as well as funding history
This will include a list of every individual who holds stock in the business, a history of fundraising efforts, and a history of any bank financing or external debt that was utilised.
Finances from the past
Five years’ worth of prior financial statements would be ideal. Although an audit of them would be wonderful, it is not absolutely necessary.
We require a fully linked, three-statement financial model in order to carry out our task. Balance sheet, income statement, and statement of cash flow are the three statements.
When there are delays or problems, it’s typically because connected three-statement predictions aren’t available in time for us to perform “what-if” analysis (e.g., “If things go worse than expected, when do things break? How much of this startup’s variable costs have to be cut back to make it financially viable and able to pay off our debt?”).
From the time we first spoke on the phone, everything I’ve described should take about 4-5 weeks. It will now be Week 6 before a term sheet is signed.
We frequently provide financing to businesses that sell to large corporations; as a result, these businesses typically have 100 or fewer clients.
As a result, we need to know how these businesses operate, how dependable their sales projections are, and how confident they are about the future. All of that aids us in determining how much we trust their financial projections.
a list of the most significant clients, both current and previous
We can determine customer concentration or turnover using comprehensive customer data. If those are quick disqualifiers, we don’t want to waste anyone’s time by going into great detail.
We deem a borrower too hazardous if their customer base is overly concentrated (fewer than 15 total customers or more than 50% of sales from just a few customers).
Another red flag or potential disqualifier is if the startup experiences a high rate of churn, which means that their current customers have decided not to renew or stick with them. Additionally, there are nuances in this.
Churn could make sense if your product has changed dramatically and in a way that we would deem sensible and positive.
With all of this data, it will be possible for us to do a desktop analysis, which generally takes two weeks. Even while we could complete it sooner if it were absolutely essential, we like to give ourselves two weeks. We would provide a term sheet if the desktop analysis is favorable.
We can create a smart framework and set of terms that are reasonable for both us and the borrower if we go about it our way. Adapting the loan to the borrower, for instance, can be possible when you actually need the funds. Maybe you need it right away, or maybe you won’t need it till later.
Other variants might include structuring the agreement so that the interest rate decreases as the firm grows or including a lengthier interest-only term where the debt isn’t amortizing since you wouldn’t be able to begin to do so until a specific event occurs.
After our initial phone discussion, I would say that everything I’ve described above should take four to five weeks. So, by Week 5, you’d probably have a term sheet.
Visiting the board
Up until this point, likely the only parties involved were the CEO and CFO. After receiving a term sheet, you should offer the contract to the board.
Some businesses involve the board right from the start of the procedure. Because a board member objected to a contract being made with a certain lender, I am aware of transactions that have failed.
It can be a personal (and biased) grudge, or maybe one of the board members is knowledgeable about the lender.
Since we have never experienced this, I advise at the very least informing your board of the lenders you are in contact with as soon as possible.
Depending on the borrower, the process may proceed fast after the board presentation stage.
They will probably review the term sheets provided by several lenders. We are the sole lender participating, I’d say, 10% of the time.
In the other 90% of cases, several lenders compete to offer growth finance. In order to meet their needs, the corporation might also contemplate using some or all equity.
You will probably need about a week to complete three or four term sheets that need to be reviewed and compared.
A contract may be quite simple in and of itself, but that doesn’t mean that every deal will be.
In addition to varying in terms of the stage at which they may make loans, lenders can also specialize in a certain industry. Of course, the terms will differ depending on the lender.