Technology companies getting billions of dollar valuations from seed or early stage rounds used to be myth – now there are over 70 tech companies that fall into this category. Venture lenders facilitate working capital and expansion needs of seed and early stage VC-backed businesses further assisting in Unicorn transformations. Are Unicorns here to stay? Maybe, but then again tulip bulbs once were priceless and the Earth has not once, but multiple times, been about to run out of oil.
Venture Lending – Changes in the Landscape
This past month in a $425 million deal, Western Alliance Bancorporation acquired Bridge Bank. Durham’s Square 1 Financial was acquired by PacWest Bancorp in a deal valued at $849 million. Ho-hum: just another couple of middle-market bank mergers? Not quite.
These two deals could signal more activity in venture lending as these new owners may seek to expand their platforms to justify their acquisition. City National is another example. City National expanded its growing technology and venture capital banking business to the East Coast, opening a loan production office in Boston, a city where more than 100 venture capital firms invest in fast-growing tech firms throughout the East Coast. In 2012, Boston received the third highest amount of venture capital investments of any metro region in the United States ... continued proof of an emphasis among banks and non-bank lenders on growing their venture capital business and focusing on tech companies.
Non-traditional funding sources such as investment bankers, venture capitalists, insurance companies, crowd funders and others, are exploring opportunities in the equipment finance sector, getting additional funding and either starting new firms or expanding their platforms to do more. New players have popped up on both coasts as well as in the southwest. Veteran venture debt professionals have been successful in raising new funds or expanding existing ones. CapX Partners is operating out of its Fund IV and raised $225 million (versus $150M in Fund III) to continue its strategy of allocating up to 30% of its capital to venture debt/leases.
Investors continue to seek outsized returns. Returns have never been tied to bank lending rates so the cash on cash returns remain very attractive to other fixed income investment alternatives. As the markets ebb and flow, venture lender returns move with either smaller or healthier warrant allocations to their debt investments. These warrants provide the yield enhancement that can make an already attractive return assumption really outperform.
Moving Forward
Sectors attracting venture lending are typically tech/software, biotech and medical. Clean energy and water-focused technology had been quite strong, but investment seems to have tailed off with valuations and exits not reaching investor timing/assumptions.
Tech/software is leading the VC investment sector and the desire to find the next Unicorn attracts both equity and venture lending to these companies. Biotech typically has long lead times for the ample trials and proving data required by the FDSA and other regulatory prior to the commercial launch of a product. The implementation of the Patient Protection and Affordable Care Act created hesitation for many hospitals and systems, as well as providing new technology to deal with the changes that these new regulations create.
Venture lenders look to follow the best of class VC’s investing into the sectors described above. The expectation of established GP experience, ample follow on capital and tracking sectors producing outsized exits will continue to attract venture lenders looking to stake their flag early into these types of risk/reward investments.
Endnotes:
(1) Equipment Leasing & Financing Association
(2) National Venture Capital Association