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Venture Leasing
In 2003, venture capitalists and investors dispensed over $18 billion to promising young U.S. 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 contributes greatly to the growth of U.S. start-ups.
Yearly, specialty leasing companies pour hundreds of millions of dollars into start-ups, permitting savvy entrepreneurs to achieve the 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 the 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 allows 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 the office.
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 the 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 the 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 has none of these drawbacks. Venture lessors typically seek an annual return in the 14% – 20% range.
These transactions usually amortize monthly in two to four years and are secured by the underlying assets. Although the risk to the venture lessor is also high, this risk is mitigated by requiring collateral and structuring a transaction that amortizes. By using venture leasing and venture capital together, the savvy entrepreneur lowers the 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 the end of the lease, the 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, the lessee has a high degree of flexibility and control.
The resulting reduction in payments and shift of lease expense beyond the expiry of the transaction can deliver a higher enterprise value to the savvy entrepreneur during the initial term of the lease. The higher enterprise value results from the 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 the 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 the companies’ assets. In some cases, they also require guarantees of the start-ups’ principals. More and more, sophisticated entrepreneurs recognize the stifling effects of these limitations and their impact on growth.
When start-ups need additional financing and a sole lender has encumbered all company assets or required guarantees, these young companies become less attractive to other financing sources. Correcting this situation can sap the entrepreneurs’ time and energy.
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