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Venture Lease Pricing
What determines venture lease pricing and how does a prospective lessee get the best deal? First, make sure you are comfortable with the leasing company. This relationship is usually more important than transaction pricing. With the rapid rise in venture leasing over the 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 the start-up stray from plan. Also, the 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 the start-up finds a capable venture lessor, negotiating a fair and competitive lease is the next order of business. A number of factors determine venture lease pricing and terms. Important factors include:
1) the perceived credit strength of the lessee
2) equipment quality
3) market rates, and
4) competitive factors within the venture leasing market.
Since the lease can be structured with several options, many of which influence the 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 the lease’s back end in the 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 the initial lease term.
Thereafter, the lessee can choose to return the equipment, purchase the equipment for 10% – 15% of equipment cost or to renew the lease for an additional year. If the lease is renewed, the lessor recovers an additional 10% – 15% of equipment cost. If the equipment is returned to the lessor, the start-up reduces its cost and limits the amount paid under the lease. The lessor will then remarket the 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 the transaction. Warrants give the lessor the right to buy an agreed upon quantity of ownership shares at a share price predetermined by the parties. Under a venture lease with warrant pricing, the lessor typically prices that lease several percentage points below a similar lease without warrants. The number of warrants the start-up proffers is arrived at by dividing a portion of the lease line – usually 3% to 15% of the line by the warrant strike price.
The strike price is typically the share price of the 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 the 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 the right people, partners, ideas, materials and tools.
Venture leasing is a useful tool for the savvy entrepreneur. When used properly, this financing tool can help early stage companies accelerate growth, squeeze the most out of their venture capital and increase enterprise value between equity rounds. Why not preserve ownership for those really doing the heavy lifting?
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