Equity, Debt & Everything in Between

I am pleased to bring you the January 2017 NetForum Key Learnings.  The NetForum meeting was hosted by John Hempill, Esq., partner at Sheppard Mullin & Richter on January 31, 2017.

With the tech market booming, capital has poured in and there is a plethora of doors to knock on for tech companies seeking capital.  This is true at the low-end, the mid-market and the pre-IPO stages.  In fact, it is my observation, as someone who has raised capital for my own startups and for many tech clients over the last 20+ years, that there is a dizzying array of choices.

Nowadays, there are a lot of different types of capital providers into the tech sector, not just more of a few types.  There are incubators, accelerators (some independent, some thematic, some affiliated with a corporate sponsor), crowdfunding, friends and family, Angels Funds, Seed Funds, Pre-A Funds, A funds, Expansion Stage Funds (B/C), Late Stage Funds (D+), Cross Over Funds (Private/Public), Growth Equity Funds, Private Equity Funds, Venture Debt Providers, Asset Based Lenders, AR Based Lenders, Family Offices, Corporate VCs, Strategic Investors and some people who do all of the above or some of the above who call themselves Multi-Stage.

They all have different requirements, expectations, and costs — based on the investment guidelines they committed to their investors or corporate sponsors.  It’s an improvement over the landscape 10 years ago. However, with choice comes confusion.

Who do call if you want $1M, $10M, $100M?  You can spend a lot of time knocking on the wrong doors.

At our NetForum breakfast, we had bankers, corporate VCs, a thematic incubator, a thematic early stage VC, CEOs and Corp dev folks.  I seeded the discussion with 3 opening questions:

  1. What are the thresholds for financings for the main categories of equity financing so that people can figure out where they fit?
  2. When do companies move into debt financing?
  3. Are there any regulatory changes that may impact the financing landscape?

Other questions came up that turned out to be even more interesting!

  1. New Players, Rules Unchanged, Mostly. The consensus was that despite the plethora of options, and names, the US tech financing world still falls into 3 buckets which we could call early, expansion and late stage.  This is probably due to the fact that the issues companies face at each stage are distinct and particular to each stage.  Investors are willing to buy into that risk or not.  You either have a product or not, have customer traction or not, and looking to accelerate growth and build scalable processes.  That’s the real buckets, the rest is noise.

A reason there for the noise is a recent hyper specialization of funds – smaller funds that look for very specific opportunities.  However, some will invest outside their mandates.  As well, some funds don’t describe what they are looking for and plan on meeting thousands of companies and invest in a tiny sliver of companies – it’s a waste of time for the pitching companies.

  1. Corporate Investors have different rules. Much has been written about the influx of corporate venture capital into the market.  Not a day goes by that you don’t read about another corporation setting up its own Corporate Venturing arm.  One important point made about these players is that they will venture into areas that traditional funds won’t go.  They are driven either by deep domain expertise that allows them to be less concerned with some market risks and/or by the strategic need to see some new product or service come into being and choosing to externalize its creation.  In that sense, Corporate VCs shine light on areas that are ignored by Silicon Valley investors, and they can add value with customer feedback and product development.  For those companies shunned by the traditional VC, they are a great opportunity.  But they are slow.
  1. Thematic Investors, including New Industry Investors. There is an emerging trend in VC land to look for neglected opportunities.  It used to be “secondary geographic markets” (Denver, Salt Lake City) but now it means new verticals.  For a while, it seemed that every Software/IT VC was doing the same few things: fintech, adtech, gaming & entertainment, security, and SaaS (a grab bag of sorts).  Lately the word Tech has been affixed to many other nouns: FoodTech, AgTech, FashionTech, BeautyTech, InsuranceTech, TransportationTech and the like.  It’s as if Marc Andreessen was right and Software really ate the world and transformed every possible industry.  New funds are launching in many new locations not because the rents are low but because these areas are home to disrupted industries and are leveraging local know-how to reboot.
  1. International is Different Now. Smart money in international VCs may be starting to focus less on getting their portfolio companies a foothold in the US market but instead focus on leveraging local cost advantages in building strong local or regional players first (or instead of looking at the US market.)  It’s a big world out there and the returns on regional players may be better on helping foreign players penetrate the US market.  That’s an interesting development.  Over the last 20 years, we have helped Israeli and French companies come to the US.  Recently, we advised a French online cosmetics pure play to stay in France, grow to #1 and be acquired by a regional or International consolidator…
  1. Debt.  There is lot of debt capital available in the market.  (Full disclosure: In addition to my investment banking activities and running Reachable, we have a partnership with a PE firm to provide debt capital to Tech companies.)  There are companies that should not take debt at any cost: unhealthy companies.  If the company’s business model is broken, layering debt will not help and is likely to precipitate the demise of the business.  But if the business is healthy, then debt is just another source of growth capital. Unlike venture capital, where you can (somewhat) negotiate your valuation by touting the achievements of your company, the cost of debt is more often than not largely determined by the cost of capital of the lender.  It does not matter how great your business is, if the lender raised its capital by promising a 15% return to its investors, the loans made by the lender will have to yield 20% more or less, and they can’t be less than 15%.  If it’s not working for you, find another lender with a lower cost of capital.
  1. Regulatory update.
    1. The experts were categorical: crowdfunding transactions volume is underwhelming. The complexity of the regulations is a major deterrent.  And it is also likely that investors are not that interested.
    2. A potentially significant change may be coming to the debt market: deductions for net interest expense may be disallowed. One motivation for doing so is to equalize the tax treatment of debt and equity financing.  This will drive the relative cost of debt higher, and that of equity lower.

 Thanks for reading! Next time, come and talk!

Laurent

https://www.linkedin.com/in/laurentohana

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