TVG Breakfast, Term Sheets and Land Mines

It was the best TVG event that I’ve seen yet. At least if you dig(g) startup finance. Rick Segal brought together Mark McQueen (Venture [debt] financer) and Suzanne Dingwall Williams (Venture Law Line) to talk about Venture Debt the traps and pitfalls of termsheets.

What I learned, piles of notes after the jump…

What the heck is Venture Debt?

It’s debt rather than equity but for higher risk firms than banks will touch.
Venture debt (can we call it VD? Dating analogies were rife at this session so why not). Anyway VD is for riskier deals than traditional debt but for many growth-stage firms can still be safer than getting in bed with VC.

• VD isn’t cheap but at 17-19% cost of capital is still substantially better than VC ~35-45%
• VD will lend based on your revenue forecasts not just on trailing financial results.
• Banks don’t really do risk-based lending. If they can’t price it under prime +2.5% they just won’t touch it, leaving a big market for VD.
• VD is rampant in the valley but something tech industry in Canada should be catching on to it more (says the guy who sells the stuff).
• Venture debt can be secured by IP (and not just patent(ed/able) IP, it’s the ability of that IP to generate cash flow that counts) so yes, as a software startup you can get VD. However, they lend to [real] companies not ideas, and not generally “to 2 guys in a garage with bad T-shirts… from the 80s”.

Catching VD could be ideal for you if

1. You’re high growth to delay dilution from taking equity
2. You have under-levered assets (not likely in tech…)
3. You expect to be generating cash flows that are much greater than past flows
4. You need more time to sell your company or close a round with Rick
5. [Mark also mentioned leveraged buyouts and industry consolidation plays (eg. Niche security software firms) fueled by VD in the valley.]

Land Mines!

• Rick: Giving up ownership. He sees a lot of startups that one investment capital but don’t want to give up ownership, founders need to get over this (or get Venture Debt instead)
• Rick: Valuation and uncle Ned. Be careful of your initial valuations, and the expectations of your initial investors. Just because your first angel (Uncle Ned) gave you $150k in exchange for 1% of the company (implied valuation: 15 million) doesn’t mean Rick is going to offer you a valuation anything close to that.
• Liquidity Event: be wary of time horizons. Ask your VC what the time horizon of this fund is (VC’s get their money from upstream investors, who in turn have expectations and timetables for when they want their money back + returns). If you are the last one into this particular pool of capital, you could find yourself squeezed into the end of a narrow time horizon.
• Suzanne: Rick is a nice guy but even in our his very friendly seeming term sheet examples (samples provided to us on CD yay!) She found several terms to push back on.
• Suzanne: a term sheet should accomplish a few things but in particular create momentum. It should have a short no-shop period (45 days) to focus all parties on closing in a timely fashion.
• Suzanne: the risk of not closing should be shared between parties. Rick’s term sheet suggests startup pays all expenses of negotiation out of the amount they are funded. Suzanne suggests rather:
  

  Company to pay only legal expenses a) if the deal closes, b) if deal does not close because company violated no shop clause c) cap amount of fees

she pushed back on paying all of the VCs expenses “Just because you decide to buy me a drink at the bar doesn’t mean I get to invoice you for the manicure I had this afternoon before I came out tonight” as in- some costs VC should accept themselves as just the costs of being in business and generating deal flow.

• Suzanne: Clarity. The term sheet should not have vague or blanket terms, these will only delay and frustrate negotiations
• Suzanne: “Subject to internal approvals”: this is just a easy/lazy way out for VC. Ask them what their approval process is or they should have approvals before they offer term sheet.
• Mark: biggest lender lie “we have no covenants” lending covenants can be a good thing, they make clear exactly what conditions of the loan are. Avoid the alternative “materially adverse” clause which could be disastrous for you down the road.
• Mark: consider bullet vs amortized loans, more on this in Mark’s blog
• Rick/all: don’t get hung up on valuation. Some (e.g. US) firms may offer higher valuations but with much more onerous terms. At the end of the day all VC/lenders need to achieve the same risk-adjusted returns on their capital. They’re going to be get it one way or another (and that was the last dating analogy of the morning).

Oh last thing I learned: Get a good lawyer!
I’d definitely recommend Suzanne, Bonus points, she’s also blogger herself, and hilarious. I