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Venture Leasing: Startup Financing On the Rise |
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 According to Pricewaterhouse Coopers, investment by institutional
venture capitalists in startups grew from less than $3.0 billion
at the
beginning of the 1990’s to over $106 billion in 2000. Although venture
capital volume has retreated significantly since the economic “bubble”
years of the late 1990’s, the present volume of around $ 19 billion per
year still represents a substantial rate of growth. Venture capitalists
will fund more than 2,500 high growth startups in the U.S. this year.
The
growth in venture capital investing has given rise to a relatively new
and expanding area of equipment leasing known as ‘venture leasing’.
Exactly what is venture leasing and what has fueled its growth since
the early 1990’s? Why has venture leasing become so attractive to
venture capital-backed startups? To find answers, one must look at
several important developments that have bolstered the growth of this
important equipment leasing segment.
The term venture leasing
describes equipment financing provided by equipment leasing firms to
pre-profit, early stage companies funded by venture capital investors.
These startups, like most growing businesses, need computers,
networking equipment, furniture, telephone equipment, and equipment for
production and R&D. They rely on outside investor support until
they prove their business models or achieve profitability. Fueling the
growth in venture leasing is a combination of several factors,
including: renewed economic expansion, improvement in the IPO market,
abundant entrepreneurial talent, promising new technologies, and
government policies favoring venture capital formation.
In this
environment, venture investors have formed a sizeable pool of venture
capital to launch and support the development of many new technologies
and business concepts. Additionally, an array of services is now
available to support the development of startups and to promote their
growth. CPA firms, banks, attorneys, investment banks, consultants,
lessors, and even search firms have committed significant resources to
this emerging market segment.
Where does equipment leasing fit
into the venture financing mix? The relatively high cost of venture
capital versus venture leasing tells the story. Financing new ventures
is a high risk proposition. To compensate venture capitalists for this
risk, they generally require a sizeable equity stake in the companies
they finance. They typically seek investment returns of at least 35% on
their investments over five to seven years. Their return is achieved
via an IPO or other sale of their equity stake. In comparison, venture
lessors seek a return in the 15% – 22% range. These transactions
amortize in two to four years and are secured by the underlying
equipment.
Although the risk to venture lessors is also high,
venture lessors mitigate the risk by having a security interest in the
leased equipment and structuring transactions that amortize.
Appreciating the obvious cost advantage of venture leasing over venture
capital, startup companies have turned to venture leasing as a
significant source of funding to support their growth. Additional
advantages to the startup of venture leasing include the traditional
leasing strong points --- conservation of cash for working capital,
management of cash flow, flexibility, and serving as a supplement to
other available capital.
What makes a ‘good’ venture lease
transaction? Venture lessors look at several factors. Two of the main
ingredients of a successful new venture are the caliber of its
management team and the quality of its venture capital sponsors. In
many cases the two groups seem to find one another. A good management
team has usually demonstrated prior successes in the field in which the
new venture is active. Additionally, they must have experience in the
key business functions—sales, marketing, R&D, production,
engineering, and finance. Although there are many venture capitalists
financing new ventures, there can be a significant difference in their
abilities, staying power, and resources. The better venture capitalists
have successful track records and direct experience with the type of
companies they financed.
The best VCs have industry
specialization and many are staffed by individuals with direct
operating experience within the industries they finance. The amount of
capital a venture capitalist allocates to the startup for future rounds
is also important. An otherwise good VC group that has exhausted its
allocated funding can be problematic.
After determining that the
caliber of the management team and venture capitalists is high, a
venture lessor looks at the startup’s business model and market
potential. It is unrealistic to expect expert evaluation of the
technology, market, business model and competitive climate by equipment
leasing firms. Many leasing firms rely on experienced and reputable
venture capitalists who have evaluated these factors during their ‘due
diligence’ process. However, the lessor must still undertake
significant independent evaluation. During this evaluation he considers
questions such as: Does the business plan make sense? Is the product/
service necessary, who is the targeted customer and how large is the
potential market? How are products and services priced and what are the
projected revenues? What are the production costs and what are the
other projected expenses? Do these projections seem reasonable? How
much cash is on hand and how long will it last the startup according to
the projections? When will the startup need the next equity round?
These, and questions like these, help the lessor determine whether the
business plan and model are reasonable
The most basic credit
question facing the leasing company considering leasing equipment to a
startup is whether there is sufficient cash on hand to support the
startup through a significant part of the lease term. If no more
venture capital is raised and the venture runs out of cash, the lessor
is not likely to collect lease payments. To mitigate this risk, most
experienced venture lessors require that the startup have at least nine
months or more of cash on hand before proceeding. Usually, startups
approved by venture lessors have raised $ 5 million or more in venture
capital and have not yet exhausted a healthy portion of this amount.
Where
do startups turn to get their leases funded? Part of the infrastructure
supporting venture startups is a handful of national leasing companies
that specialize in venture lease transactions. These firms have
experience in structuring, pricing and documenting transactions,
performing due diligence, and working with startup companies through
their ups and downs. The better venture lessors respond quickly to
lease proposal requests, expedite the credit review process, and work
closely with startups to get documents executed and the equipment
ordered. Most venture lessors provide leases to startups under lines of
credit so that the lessee can schedule multiple takedowns during the
year. These lease lines typically range from as little as $200,000 to
over $ 5,000,000, depending on the start-up’s need, projected growth
and the level of venture capital support.
The better venture
lease providers also assist customers, directly or indirectly, in
identifying other resources to support their growth. They help the
startup acquire equipment at better prices, arrange takeouts of
existing equipment, find additional working capital funding, locate
temporary CFO’s, and provide introductions to potential strategic
partners--- these are all value-added services the best venture lessors
bring to the table.
What is the outlook for venture leasing?
Venture leasing has really come into its own since the early 1990s.
With venture investors pouring tens of billion of dollars into startups
annually, this market segment has evolved into an attractive one for
the equipment leasing industry. The most attractive industries for
venture leasing include life sciences, software, telecommunications,
information services, medical services and devices, and the Internet.
As long as the factors supporting the formation of startups remain
favorable, the outlook for venture leasing continues to look promising.
 George
Parker is a Director and Executive Vice President of Leasing
Technologies International, Inc. (“LTI”), responsible for LTI’s
marketing and financing efforts. A co-founder of LTI, Mr. Parker has
been involved in secured lending and equipment financing for over
twenty years. Mr. Parker is an industry leader, frequent panelist and
author of several articles pertaining to equipment financing. Headquartered
in Wilton, CT, LTI is a leasing firm specializing nationally in direct
equipment financing and vendor leasing programs for emerging growth and
later-stage, venture capital backed companies. www.ltileasing.com
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