In 2003, venture capitalists and investors dispense over $18 billion to promising young US companies, according to VentureOne and Ernst & Young Quarterly Venture Capital Report. Less documented and reported is venture leasing’s activity and volume. This form of equipment financing contributed greatly to
growth of US start-ups. Yearly, specialty leasing companies pour hundreds of millions of dollars into start-ups, permitting savvy entrepreneurs to achieve biggest 'bang for their buck' in financing growth. What is venture leasing and how do sophisticated entrepreneurs maximize enterprise value with this type of financing? Why is venture leasing a cheaper and smarter way to finance needed equipment when compared to venture capital? For answers, one must look closely at this relatively new and expanding form of equipment financing specifically designed for rapidly growing venture capital-backed start-ups.The term venture leasing describes leasing of equipment to pre-profit, start-ups funded by venture capital investors. These companies usually have negative cash flow and rely on additional equity rounds to fulfill their business plans. Venture leasing originated to allow growing start-ups to acquire needed operating equipment while conserving expensive venture development capital. Equipment financed by venture leases usually includes essentials such as computers, laboratory equipment, test equipment, furniture, manufacturing and production equipment, and other equipment to automate office.
Using Venture Leasing Is Smart
Venture leasing enjoys many advantages over traditional venture capital and bank financing. Financing new ventures can be a high risk business. Venture capitalists generally demand sizeable equity stakes in companies they finance to compensate for this risk. They typically seek investment returns of at least 35% - 50% on their unsecured, non-amortizing equity investments. An IPO or other sale of their equity position within three to six years of investing offers them best avenue to capture this return. Many venture capitalists require board representation, specific exit time frames and/or investor rights to force a 'liquidity' event. In comparison, venture leasing – having none of these drawbacks - specifically helps young companies acquire equipment for growth. Venture lessors typically seek an annual return in 14% - 20% range. These transactions usually amortize monthly in two to four years and are secured by underlying assets. Although risk to venture lessor is also high, this risk is mitigated by requiring collateral and an amortizing transaction. By using venture leasing along with venture capital, savvy entrepreneur lowers venture's overall capital cost, builds enterprise value faster and preserves ownership.
Venture leasing is also very flexible. By structuring a fair market value purchase or renewal option at end of lease, start-up can slash monthly payments. Lower payments result in higher earnings and cash flow. Since a fair market value option is not an obligation, lessee has a high degree of flexibility and control. The resulting reduction in payments and shift of lease expense beyond expiry of transaction can deliver a higher enterprise value to savvy entrepreneur during initial term of lease. The higher enterprise value results from start-up’s ability to achieve higher earnings, upon which most valuations are based.
Customers benefit more from venture leasing as compared to traditional bank financing in two ways. First, venture leases are usually only secured by underlying equipment. Additionally, there are usually no restrictive financial covenants. Most banks, if they lend to early stage companies, require blanket liens on all of companies' assets. In some cases, they also require guarantees of start-ups’ principals. More and more, sophisticated entrepreneurs recognize stifling effects of these limitations and their impact on growth. When start-ups need additional financing and a sole lender has encumbered all assets or required guarantees, these young companies become less attractive to other financing sources. Correcting this situation can sap entrepreneurs’ time and energy.
How Venture Leasing Works
Generally, a major round of equity capital raised from credible investors or venture capitalists makes venture leasing viable for early stage company. Lessors structure most transactions as master lease lines, permitting lessee to draw down on line as needed throughout year. Lease lines usually range in size from as little as $ 200,000 to well over $ 5,000,000, depending on lessee's need and credit strength. Terms are typically between twenty four to forty eight months, payable monthly in advance. The lessee's credit strength, quality and useful life of underlying equipment, and lessor’s anticipated ability to re-market equipment during lease often dictate initial lease term. Although no lessor enters a leasing arrangement expecting to re-market equipment prior to lease expiry, should lessee’s business fail, lessor must pursue this avenue of recovery to salvage transaction. Most venture leases give lessees flexible end-of-lease options. These options generally include ability to buy equipment, to renew lease at fair market value or to return equipment to lessor. Many lessors cap fair market value, which also benefits lessee. Most leases require lessee to shoulder important equipment obligations such as maintenance, insurance and paying required equipment taxes.
Venture lessors target lessee prospects that have good promise and that are likely to fulfill their leases. Since most start-ups rely on future equity rounds to execute their business plans, lessors devote significant attention to credit review and due diligence - evaluating caliber of investor group, efficacy of business plan and management's background. A superior management team has usually demonstrated prior successes in field in which new venture is active. Additionally, management’s expertise in key business functions -- sales, marketing, R&D, production, engineering, finance --- is essential. Although there are many professional venture capitalists financing new ventures, there can be a significant difference in their abilities, staying power and resources. The better venture capitalists achieve excellent results and have direct experience with type of companies being financed. The best VCs have developed industry specialization and many have in-house specialists with direct operating experience within industries covered. Also important to venture lessor are amount of capital VCs provide start-up and amount allocated for future funding rounds.
