After determining that management team and venture capital investors are qualified, venture lessors evaluate start-up’s business model and market potential of venture. Since most venture lessors are not technology specialists – able to assess products, technology, patents, business processes and like - they rely greatly on thorough due diligence of experienced venture capitalists. But experienced venture lessor does undertake an independent evaluation of business plan and conducts careful due diligence to understand its content. Here, lessor generally attempts to understand and concur with business model. Questions to be answered include: Is business model sensible? How large is market for prospect's services or products? Are income projections realistic? Is pricing of product or service sensible? How much cash is on hand and how long will it last according to projections? When is next equity round needed? Are key people needed execute business plan in place? These and similar questions help determine whether business model is reasonable.

Satisfied that business model is sound, venture lessor’s greatest concern is whether start-up has sufficient liquidity or cash on hand to support a significant portion of lease term. If venture fails to raise additional capital or runs out of cash, lessor is not likely to collect further lease payments. To mitigate this risk, most experienced venture lessors pursue start-ups with at least nine months of cash or sufficient liquid assets to service a substantial portion of their leases.

Getting Best Deal

What determines venture lease pricing and how does a prospective lessee get best deal? First, make sure you are comfortable with leasing company. This relationship is usually more important than transaction pricing. With rapid rise in venture leasing over past decade, a handful of national leasing companies now specialize in venture leases. A good venture lessor has a lot of expertise in this market, is accustom to working with start-ups, and is prepared to help in difficult cash flow situations should start-up stray from plan. Also, best venture lessors deliver other value-added services - such as assisting in equipment acquisitions at better prices, trading out existing equipment, finding additional venture capital sources, working capital lines, factoring, temporary CFOs, and introductions to potential strategic partners.

Once start-up finds a capable venture lessor, negotiating a fair and competitive lease is next order of business. A number of factors determine venture lease pricing and terms. Important factors include: 1) perceived credit strength of lessee, 2) equipment quality, 3) market rates, and 4) competitive factors within venture leasing market. Since lease can be structured with several options, many of which influence ultimate lease cost, start-ups should compare competing lease proposals. Lessors typically structured leases to yield 14% - 20%. By developing end-of-lease options to better accommodate lessees' needs, lessors can shift some of this pricing to lease’s back end in form of a fair market value or fixed purchase or renewal option. It is not uncommon to see a three year lease structured to yield 9% - 11% annually during initial lease term. Thereafter, lessee can choose to return equipment, purchase equipment for 10% - 15% of equipment cost or to renew lease for an additional year. If lease is renewed, lessor recovers an additional 10% - 15% of equipment cost. If equipment is returned to lessor, start-up reduces its cost and limits amount paid under lease. The lessor will then remarket equipment to achieve its 14% - 20% yield target.

Another way that leasing companies can justify slashing lease payments is to incorporate warrants to purchase stock into transaction. Warrants give lessor right to buy an agreed upon quantity of ownership shares at a share price predetermined by parties. Under a venture lease with warrant pricing, lessor typically prices that lease several percentage points below a similar lease without warrants. The number of warrants start-up proffers is arrived at by dividing a portion of lease line - usually 3% to 15% of line - by warrant strike price. The strike price is typically share price of most recently completed equity round. Including a warrant option often encourages venture lessors to enter transactions with companies that are very early in development or where equipment to be leased is of questionable quality or re-marketability.

Building a young company into an industry leader is in many ways similar to building a state-of-the art airplane or bridge. You need right people, partners, ideas, materials and tools. Venture leasing is a useful tool for savvy entrepreneur. When used properly, this financing tool can help early stage companies accelerate growth, squeeze most out of their venture capital and increase enterprise value between equity rounds. Why not preserve ownership for those really doing heavy lifting?

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