By William H. Payne

Bank Debt for Venture-Backed Companies
In the past decade, a few banks across the U.S. have been providing debt financing for companies that have secured equity capital from venture capitalists. The most well known is Silicon Valley Bank. However, other banks are also sources of such debt financing. Not surprisingly, this debt is available primarily in regions of the country where venture capitalists are particularly active, such as Silicon Valley and near Boston.

This debt is used by high-growth, later-stage companies to supplement venture capital in rapidly ramping up growth, and is often available to companies that can quickly pass the break-even point in cash flow necessary to pay back the debt. The banks that offer this debt depend on the due diligence of trusted venture capitalists to validate the quality of the management team and the business plan. The size of these loans is often proportional to the amount of venture capital raised by the company, perhaps 20 percent to 30 percent of the amount of equity capital, depending on the quality and maturity of the company. This debt financing would likely be a combination of equipment loans and a line of credit.

These banks buck the trend by lending to entrepreneurial ventures for a number of reasons. First, they are lending in concert with known and trusted venture capitalists. Second, in addition to relatively high business interest rates, these bankers usually require "warrant coverage," that is, the opportunity for the lender to purchase stock later, once the company is successful, at very attractive pricing.

By making many such loans to venture-funded companies, they can achieve an attractive supplemental return on their investment from the equity piece (warrants) of these debt packages. It is important to add that these banks have ongoing relationships with venture capitalists and their limited partners and are developing strong banking ties with exciting companies who often become major bank customers over many years into the future.

BOTTOM LINE.  While a few banks offer debt financing to venture-backed companies, it is important to put this source of funding into perspective. While more than 500,000 companies are started each year in this country, only 1,000 solicit their first round of venture capital, and only a fraction of that 1,000 also receives bank financing from these sources. Although bank debt is a very attractive source of funding for entrepreneurs, it is available to only a very small number of entrepreneurs each year.

In summary, debt financing in amounts greater than $100,000 is not available to entrepreneurs starting and growing new ventures until the assets of the company can collateralize the loan. Some debt financing in these amounts is available to a few selected venture-backed companies. In a very few regions of the country, modest debt is available to entrepreneurs from non-bank entities, but these sources are very rare indeed. Finally, convertible debt and bridge loans are debt instruments provided by equity investors and are considered by entrepreneurs to be a variation of equity investments.

William H. "Bill" Payne, a Midwesterner by birth, moved to Southern California after earning his engineering degrees at the University of Illinois in the mid 1960s. After working in engineering positions for two Fortune 1000 companies, he co-founded Solid State Dielectrics, Inc. an electronic materials company in 1971, which was sold to E. I. DuPont Nemours in 1982. He was involved in the launch of five other enterprises. Since the early 1980s, Payne has made angel investments in 25 early-stage companies and served on the boards of about a dozen. Since 1995, he has been an Entrepreneur-in-Residence at the Ewing Marion Kauffman Foundation. His most recent project at the Kauffman Foundation has been the development and delivery of a full-day seminar on angel investing. Payne has over 120 years of board experience for private companies and not-for-profit organizations. In addition to his current involvement with 10 early-stage companies, Payne is active in the San Diego Tech Coast Angels and the Chairmen's RoundTable, a San Diego mentoring organization, the San Diego Social Venture Partners, a venture philanthropy, and the Aztec Venture Network, an angel fund.

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