Over the past 3 years, we have raised and deployed some $10 million in venture capital to build out our products and infrastructure and expand our marketing reach at Practice Technologies (www.practicetechnologies.com). As we approach operating profitability, we have a series of important questions to answer as we continue to pursue great market opportunities:
- When should we supplement our ability to internally fund growth with additional capital infusions? Considerations include business focus, valuation issues, and the availability of various capital sources.
- What are the implications of the various funding alternatives to important constituents (investors, management and our customers)? For example, debt takes a senior position in the capital structure to equity holders, and you will have various loan covenants and triggers relative to financial plans and balance sheet ratios. Make sure these are well understood as you are aggressively chasing market growth.
- How do you balance the competing interests of your stakeholders?
- What is the true cost of each potential source of capital?
Given our stage of development (post revenue, several successful products, positive cash flow), we’re able to consider securing a somewhat traditional bank line of credit. I say “somewhat” because, being a technology and content provider, we don’t have a lot of traditional assets to collateralize, and until recently, we haven’t had the cash flow to justify a bank line from commercial banks. Fortunately, there are some great lenders for companies like us, including Silicon Valley Bank, Comerica, and a relatively new entrant that we’re quite impressed with, Square One. These banks are looking to make a premium over traditional lenders through warrants and fees, and in establishing a long term banking relationship with a hopefully growing new company. In return, they are providing lower cost capital in the $500k-$2mm range to allow you to stretch into better valuation milestones. They are not a substitute for larger venture financing or in situations where current cash flow can’t meet line repayment obligations.
In the “fixing to get ready” category, the banks will suggest putting together the following materials for your initial discussions:
- 2 years historical and YTD Financial Statements
- 2 Year (Current plus Next Year) Forecast Financials (Income statement, Balance Sheet, and Cash Flow Statement)
- Aged listings of A/R and A/P
- Current Capitalization Table
- Most recent Power Point Deck used in connection with fund-raising or Board communication (to gather a sense for the market opportunity, the competitive landscape, the technological differentiator(s), the Management Team, etc.)
In addition to these, I’d add a few more (some obvious, some not so much):
- In the obvious category, take care of the general housekeeping. Make sure you’re all caught up with tax and corporate compliance issues. These deals are all about credibility, and potentially they can be time sensitive.
- As much as it can seem like it’s all about the numbers, the good ones in the venture-backed technology lending space are looking to the following in evaluating the application (in some order):
- Your venture partners. Are they excited about your growth prospects, or are they getting tired? And why do they feel that a line is more appropriate at this time than another venture round?
- The management team. Is it seasoned, well grounded and reasonable? Do the financial projections make sense, or do they look like an enormous hockey stick? (See my previous post on financial projections for further comments.)
- Understanding the business opportunity. Your venture backers got in, but is it something the bankers can get excited about? And how much of a banking opportunity is it?
- As an entrepreneur, you need to be able to succinctly talk about your business, and you’re always selling. This is no exception. Again, with your feet firmly planted on the ground, be able to present this as an exciting opportunity.
- Start building those relationships early. The longer they have to get to know you and watch the business, the more comfortable they will be.
One of our challenges is to value the true price of the line relative to other potential sources of credit. In addition to the hard costs (application fees, interest expense, etc.), the line has a finite life and must be repaid. Assuming it is not refinanced, against a $500k line that is fully drawn down in the first year, you might have about $150-200k in costs over the 4 year period (the draw down, plus say a 3 year repayment) for temporary access to $500k in Yrs 1-2, $300k in Year 3, and $150k in Year 4.
Surprising? Look at the breakdown:
- Application fee – $15-25k (including legal)
- Warrants – 3% of line ($45k in exercise price – value is up to you)
- Interest costs – 12-14%/yr, or $60-75k in years 1-2, $40-50k in year 3, and $25k in year 4.
True, you’re ideally providing your venture investors with a 35-40% ROI over that period, which compounds very quickly, and there are plenty of other strings attached. But at least you’re not repaying that money over what might be a cash-constrained period, and your venture investors are all about value creation, not loan repayments. Oh, and if you secure a new venture round, new money is generally not fond of paying off prior obligations.
I’ll keep you posted as the discussions unfold over the next 3 months.
John Siegler's Blog 
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