New and modified loans are available from banks and venture capital debt funds if your start-up needs help getting through the downturn, but the process will take longer than normal, especially if you don't already have a debt facility with the lender.
"We are still absolutely open for business," says Jake Moseley, senior market manager at Silicon Valley Bank. "At the same time, a real prioritization is taking place."
Like most companies grappling with the pandemic, banks and venture debt funds aren't spending most of their time building new business. Early-stage underwriting risk is too uncertain. Their focus instead is on working with existing clients.
"We're dealing with capacity challenges," Moseley said in an Airbase webcast, "Not just venture debt funds, but lenders in general."
For that reason, if you already have a debt facility with a bank or venture debt fund, you'll want to start the process now if you're seeking to get terms eased, or to add a new debt line, even if your existing debt doesn't expire for another year or two.
Principal amortization deferral
If you're seeking loan term changes, you're more likely to negotiate a deferral in your principal than in your interest payments, Goodwin law firm partner Mark Smith said in the webcast.
"Borrowers routinely ask for and lenders routinely grant a temporary deferral of principal repayment," Smith said. "Borrowers usually don't ask for and rarely get a deferral of interest payments, except for extreme circumstances. That's just not one of the options."
If you negotiate a deferral of principal amortization, you can expect to get a break for three to six months in exchange for an upfront fee. You might also pay a second fee — what Smith called a success fee — that comes due when you pay the loan back.
In addition to initiating those conversations as soon as possible, the specialists said, be transparent with your lender about your company's pandemic challenges.
"Don’t hide," Moseley said. "Don’t make them chase you. Let them know what you know."
As part of the due diligence process, the lender will talk to your investors, look at your management, and see what steps you're taking to get your burn rate down. "They just want to make sure nothing is fundamentally broken," said Smith. "It's just going to take longer to get to the place we both thought you were going to get."
New debt facility
If you're thinking of obtaining new financing, determine whether you need it now or can wait a year or 18 months.
"Understand the velocity and volume of requests the financial institutions need to deal with," Moseley said. "It's good to have that perspective."
If you have the capacity to make it another six to 12 months, you’ll still want to start your conversation with the lender now.
"Express interest. Let them know you have an interest in exploring this further," Moseley said. It may take a little bit more time. My absolute belief is that, as we come out of this and capacity starts to increase, the market will be very healthy for accessing venture debt."
There are two reasons companies typically want to add debt. The first is as a kind of insurance policy, a source of money to fall back on if it's needed, and the second, if you’ve moved beyond the early stage to a growth stage, to extend your runway and scale your operations. It's also good to have that debt as you negotiate on the equity side with investors.
For new debt, you can expect to get a loan for between 15% and 40% of your invested equity, said Smith. The interest rate will typically be Wall Street Journal prime plus anywhere from 70 to 100 basis points. You can also expect a modest upfront fee, from 50 to 100 basis points, and a backend "success" fee at loan pay-off, which is usually 1.5-4.5%.
Your toughest negotiation probably won't be the size of the loan; it will probably be how it's metered out. Lenders are unlikely to give you the full amount at once.
"Especially for early stage companies, the lender wants you to be tranched," said Smith. "They'll say, 'Look, we’ll give you $5 million, but we’re not going to give you $5 million to take down on day one. You can have $2.5 million on day one; the other $2.5 million will be tied to the achievement of some agreed-upon milestone.'"
That milestone is typically a revenue or equity investment target or, in the case of a life sciences company, a clinical trial.
Making too much money available too quickly can become a negative for the borrower, because it can burden management with covenants that can make it hard to grow later.
"It puts pressure on the relationship," said Moseley. "It puts pressure on the investors and especially in a market like today, where equity rounds become more uncertain. So, metering out or tranching these facilities is a way to align those interests, gives the company what they’re looking for in terms of total dollars, while doing that at the right point in time."
Lender restrictions
Expect the covenants lenders put on their loans to remain standard despite the downturn. These typically include requirements that you pay your taxes, deliver your financial statements, and give the lender a heads up on any events. They also typically include prohibitions on borrowing additional money from other lenders or granting security interests or liens in the assets, since the assets are the lender's collateral.
The most problematic covenants tend to be those that restrict your participation in any merger or acquisition. "Often borrowers pause on that and say they want the ability to do this if the right opportunity comes," Smith said.
All of these covenants are typically flexible, including the M&A restriction. Lenders generally just want to discuss the strategy behind what your company wants to do. If it makes sense to you and the equity investors on your board, it will probably make sense to the lender as well.
Bottom line: You and your lender share the same goal, Moseley said. "They want you to get through the downturn. "They want you to borrow the money and pay it back so they can do it again with your company for larger sums of money,” he said. "That's the whole point they’re playing for."
