I happened across a blog post by Sarah Tavel of Bessemer Venture Partners, and it pretty much outlined why the U.S. venture market has responded so well to Wellington’s non-amortizing venture debt product. What we call “True Growth Capital”.
This is the most detailed financial analysis on venture debt I’ve seen from the VC industry, and it ultimately makes the point that we’ve been stressing since we issued our first venture debt term sheet for a VC-sponsored company back in 2001. We were up against some local guys offering the traditional venture debt product, which requires monthly amortization of principal and interest after a short “interest only” period, aka a 6 or 9 month principal holiday. By offering a non-amortizing loan, we ensured that the company was able to use all of the capital we were providing, rather than require that they begin to repay that loan shortly after it was issued.
It was a novel approach to tech lending, as, up until that point, the 30 year tradition in venture debt land had been this 36 or 42 months of blended P&I payments. Well, our marketshare of private venture debt loans to VC-backed Canadian companies went from zero to over 50% by 2006. As former Celtic House partner Ron Dizy told a CVCA audience at the Exchange Tower at one point in 2004 or so: “amortizing venture debt only adds 3 months of runway”. The rest is history: when you’ve got the VCs doing the critiques themselves, you don’t need to do much selling of your own structure.
Once we began marketing the product to American VCs in 2009, our Boston-based ally at Silicon Valley Bank said people assumed “it was too good to be true, and that we’d have to do a deal or two”. Well, after 10 deals in this neck of the woods, that’s no longer what we hear. Just as we found with Canadian CFOs, when given the choice, American executives and their VC partners would rather use their debt to grow the business. Why pay it back prematurely?
It is, after all, why they raised the debt in the first place.
According to Sarah’s analysis, a traditional amortizing venture debt loan with a 6 or 9 month principal holiday has an effective cost of capital of 27-35%; that’s still cheaper than a 40% notional cost of equity, mind you, and the VCs get to keep their powder dry for another deal. If the borrower is able to negotiate a 12 month holiday, that cost of capital becomes ~22%. For those of us in the 24-36 month principal holiday debt business, she estimates the cost of capital to be below 15%.