Each year, venture capitalists finance more than 2,500 start-ups in the US Many of these companies try to conserve their equity capital by approaching venture leasing companies to secure equipment financing. By obtaining lease financing, these smart firms can use their equity capital for high-impact activities such as recruiting key personnel, developing products, and expanding their marketing efforts.
What are the qualities that make some startups more attractive to venture lessors than others? Here are ten factors that most venture lessors evaluate when deciding which startups to finance:
Management team caliber
Most business lessors consider the start-up management team to be the most critical success factor for the business. Although it can be challenging to quickly assess managerial talent, there are several qualities that business lessors consider. They are looking for experienced managers with high integrity and a proven track record of business performance.
Quality of venture capital sponsors
Another important factor for most venture lessors is the quality of startup venture capital sponsors. Venture lessors look for experienced venture capitalists with a successful investment performance over several years. Venture capitalists should also have a good reputation for dealing fairly with creditors who serve their portfolio companies. Before entering into new leases, most venture lessors verify that venture capital sponsors of startups are actively supporting them.
Soundness of the business plan
Successful startups often have well-articulated and compelling business plans. Lessors look for signs that startups have promising market opportunities, clear and credible projections, and reliable financial statements.
Cash position / Monthly burn rate
One criterion used by many risk lessors to measure risk is the projected start-up cash consumption rate. The ratio of available cash to the startup’s monthly consumption rate is a useful measure. It crudely determines how long the startup can take before a new round of action is needed. The lessor considers a transaction less risky if the startup can make full payments for a significant part of the lease term without raising additional capital. Most lessors look for a ratio that supports at least 9 to 12 months of startup operation.
Equipment quality
The quality and intended use of the equipment is an important factor for most risk lessors. Most lessors seek transactions involving equipment that is essential to the operation of the start-up. In addition, the equipment must have acceptable collateral value and be readily marketable on the equipment aftermarket.
Product insights and revenue history
If the start-up is in the development stage and has yet to sell products, venture lessors generally look for products capable of establishing a solid position in the market. If the start-up proceeds are already in distribution, lessors look for strong monthly or quarterly revenue growth. Poor product reception in the early stages, when compared to the business plan, can often indicate a faulty product launch or a faulty product concept.
Valuation history
A valuation history records the prices of the shares sold to investors by the start-up. Unless there is a good explanation, most lessors look for significant stock price appreciation in successive rounds of offering. The assumption is that the startup is making steady and significant progress in its development, which will be reflected in the increase in share value.
Balance sheet strength
Venture lessors generally assess the startup’s working capital to ensure that the startup can make payments when due. Along with an analysis of the start-up burn rate, lessors use traditional working capital measures such as current and rapid ratios. Lessors also look for other signs of balance sheet strength, such as: low to moderate leverage; positive tangible equity (including subordinated debt); and minimum paid-in capital of $ 7 – $ 10 million.
External professional participation
Most venture lessors see the involvement of well-known and successful external board members as a positive factor for startups. A licensed public accountancy firm, law firm, institutional partners, and / or service providers are also considered positive by landlords. These professionals can bring valuable knowledge and contacts that can help the new business succeed.
Payment performance
As with more traditional tenants, venture leasing companies disapprove of tenants’ poor payment records. Most venture lessors expect tenants to have a satisfactory payment history, unless good explanations can be provided. Like other suppliers, successful payment of invoices by customers is where rubber meets the road. Whether the tenant is a startup or a Fortune 500 company, most landlords view prompt payment as sacrosanct.
While risk lessors use additional factors to make their credit decisions, these ten factors seem to be used universally. Although most of these factors are subjective, they have stood the test of time for risk lessors to make reasonable and informed credit decisions.