Risk Leasing: Startup Financing on the Rise

According to Pricewaterhouse Coopers, investment by institutional venture capitalists in startups grew from less than $ 3 billion in the early 1990s to more than $ 106 billion in 2000. Although the volume of venture capital has declined significantly since the economic “bubble” of recent years. 1990, the current volume of about $ 19 billion per year still represents a substantial growth rate. Venture capitalists will fund more than 2,500 high-growth startups in the US this year.

The growth of venture capital investment has given rise to a relatively new and expanding area of ​​equipment leasing known as “venture leasing.” What exactly is venture leasing and what has driven its growth since the early 1990s? Why has venture leasing become so attractive to venture capital-backed startups? To find answers, one must look at several major developments that have fueled the growth of this important equipment leasing segment.

The term venture leasing describes equipment financing provided by equipment leasing companies to early-stage, pre-profit companies financed by venture capital investors. These startups, like most growing companies, need computers, network equipment, furniture, telephone equipment, and equipment for production and R&D. They depend on the support of outside investors until they prove their business models or achieve cost effectiveness. Driving growth in business leasing is a combination of several factors, including: renewed economic expansion, improving IPO market, abundant entrepreneurial talent, promising new technologies, and government policies favoring venture capital formation.

In this environment, venture capitalists have formed a sizeable venture capital pool to launch and support the development of many new technologies and business concepts. In addition, a variety of services are now available to support the development of new businesses and promote their growth. Public accounting firms, banks, lawyers, investment banks, consultants, lessors, and even search firms have devoted significant resources to this emerging market segment.

Where does equipment leasing fit in the venture financing mix? The relatively high cost of venture capital versus venture leasing tells the story. Financing startups is a high-risk proposition. To compensate venture capitalists for this risk, they generally require a substantial equity stake in the companies they finance. They typically seek investment returns of at least 35% on their investments over five to seven years. Your return is achieved through an initial public offering or other sale of your equity stake. By comparison, venture lessors look for a return in the range of 15% to 22%. These transactions pay off in two to four years and are guaranteed by the underlying equipment.

Although the risk to risk lessors is also high, risk lessors mitigate risk by having a collateral in leased equipment and structuring transactions that amortize. Realizing the obvious cost advantage of venture leasing over venture capital, start-ups have turned to venture leasing as an important source of financing to support their growth. Additional advantages for venture leasing start-up include the strengths of traditional leasing: conservation of cash for working capital, cash flow management, flexibility, and service in addition to other available capital.

What Makes a Risk Lease Transaction “Good”? Venture lessors look at several factors. Two of the main ingredients of a successful startup are the caliber of your management team and the quality of your venture capital backers. In many cases, the two groups seem to meet. A good management team has generally demonstrated previous successes in the field in which the new company is active. In addition, they must have experience in key business functions: sales, marketing, R&D, production, engineering, and finance. Although there are many venture capitalists who fund startups, there can be a significant difference in their skills, staying power, and resources. The best venture capitalists have a successful track record and direct experience with the type of companies they financed.

The best VCs have industry expertise and many are staffed by people 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 venture capital group that has exhausted allotted funds 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 an expert assessment of technology, market, business model, and competitive climate from equipment leasing companies. Many leasing firms rely on reputable and experienced venture capitalists who have evaluated these factors during their “due diligence” process. However, the landlord has yet to conduct a meaningful independent evaluation. During this evaluation, consider questions such as: Does the business plan make sense? Is the product / service necessary, who is the target customer and how big is the potential market? How are the prices of products and services set and what is the projected revenue? What are the production costs and what are the other projected expenses? Do these projections seem reasonable? How much cash is available and how long will the startup take according to projections? When will the startup need the next round of actions? These, and questions like these, help the landlord determine if the business plan and model are reasonable.

The most basic credit question facing the leasing company that is considering leasing equipment to a startup is whether there is enough cash available to support the startup for a significant portion of the lease term. If no more venture capital is raised and the business runs out of cash, the lessor may not collect the lease payments. To mitigate this risk, more experienced venture lessors require the startup to have at least nine months or more of cash on hand before proceeding. Typically, venture lessor-approved startups have raised $ 5 million or more in venture capital and haven’t used up a good portion of this amount yet.

Where do startups go to finance their leases? Part of the infrastructure that supports venture start-ups is a handful of national leasing companies that specialize in business leasing transactions. These firms are experienced in structuring, pricing and documenting transactions, conducting due diligence, and working with startups through their ups and downs. The best business lessors respond quickly to requests for lease proposals, expedite the credit review process, and work closely with startups to execute documents and order equipment. Most venture lessors provide leases to startups under lines of credit so that the lessee can schedule multiple write-offs during the year. These lease lines typically range from $ 200,000 to more than $ 5,000,000, depending on startup needs, projected growth, and level of venture capital support.

The best risk leasing providers also help clients, directly or indirectly, identify 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’s the outlook for risk leasing? Venture leasing has become a reality since the early 1990s. With venture investors investing tens of billions of dollars in startups annually, this market segment has become an attractive one for the leasing industry. of Equipements. The most attractive industries for business leasing include life sciences, software, telecommunications, information services, medical devices and services, and the Internet. As long as the factors supporting new business formation remain favorable, the outlook for business leasing remains promising.

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