Our client (the “Company”) has spent the past seven years developing cutting edge technology for the banking industry and, after filing more than 40 patents, they were ready to take the product to the marketplace.
Management had secured pilot projects with customers and were in the process of rolling out their platform to bring in significant revenues. In order to begin the pilot projects, they needed $250K (their initial ask) to manufacture the necessary equipment to deliver the technology. The business has considerable upside potential with a strong management team in place.
The Financing Issue
The Company was pre-revenue and as a result of all of the R&D required to develop the product, had incurred large losses over the years. Other than the intellectual property, there were no assets that could be pledged as collateral for either a traditional or a non-traditional financing solution. The shareholders had reached their cap in terms of additional equity injections and were looking for an alternative solution to fund the manufacturing cost of the equipment.
We were able to find a non-traditional lender that offered a solution called a Venture Loan, which does not require tangible assets as collateral and is willing to lend to early stage businesses, providing they currently are or very close to generating revenues. This lender focuses on the future cash flows of the business and the upside the financing will provide.
In addition to the equipment, the lender was also willing to fund expected operating losses over the next year to bridge the financing gap even further. In total, the Company borrowed over $700,000, much higher than the actual costs to manufacturer the required equipment. Management was able to turn its focus to continuing to grow the business and capitalize on the significant momentum it had built up.
Unlike a traditional term loan where principal payments are made monthly at a fixed amount, the principal payments are made quarterly at a predetermined percentage of revenues and interest is paid monthly at rates ranging from 15%-18% per annum. The loans are typically repaid over three years and are open for repayment after the first year without penalty. Although the lender takes charge over the assets of the Company, they do not require being in first position and encourage the business to seek more traditional working capital solutions while the loan is in place. The lender generally requires only a limited personal guarantee which can be removed, albeit at a small interest rate increase.
As a part of this financing, the lender also has the right to purchase shares at a later date (warrants or options) for equity in the Company. They do a “back-of-the-napkin” valuation of the Company to come up with a strike price for the warrants which typically equals approximately 5-7% of the fully diluted value of the Company. If the lender chooses to exercise its right to purchase the shares, they pay cash for them and typically have 5 years to exercise the option. If they do not, the options simply expire at maturity.
This solution is ideally suited for businesses that require levels of financing that neither a traditional nor asset-based lender can accommodate, but the business owner prefers not to source this cash need via an equity raise as they do not want to dilute their ownership.
Eric Friedberg is a Senior Consultant with the Business Financing group at Farber. He focuses on arranging innovative financing solutions for small and medium-sized enterprises(SMEs) and early stage companies. Eric can be reached at 416.496.3078 and firstname.lastname@example.org.