Venture Leasing – A Smarter Way To Build Enterprise Value


In 2003, according to VentureOne and Ernst & Young, venture capitalists and investors contributed more than $ 18 billion to promising US start-ups, according to the quarterly venture capital report. The activity and volume of venture leasing are less documented and reported. This form of equipment financing is a major contributor to the growth of start-ups in the United States. Each year, specialized leasing companies invest hundreds of millions of dollars in start-up businesses, enabling savvy entrepreneurs to achieve the best return in terms of financing growth. What is leasing and how do savvy entrepreneurs maximize the value of the business with this type of financing? Why is leasing a cheaper and smarter way to finance the necessary equipment compared to venture capital? For answers, this relatively new and expanding form of financing for equipment specifically designed for high-growth, venture-backed start-ups needs to be carefully examined.

The term "leasing" refers to the rental of equipment to start-up, for-profit enterprises, financed by venture capitalists. These companies generally have negative cash flows and rely on additional capital raising to carry out their projects. Venture capital leasing allows new and growing companies to acquire the necessary operating equipment while retaining costly development capital. Equipment financed under operating leases generally includes basic equipment such as computers, laboratory equipment, test equipment, furniture, manufacturing and production equipment, and other equipment to automate the process. office.

Use business leasing, that is smart

Leasing has many advantages over traditional venture capital and bank financing. Financing new businesses can be a high-risk activity. Venture capital companies generally require large holdings in the companies they fund to offset this risk. They generally look for investment returns of at least 35% to 50% on their investments in unsecured and unamortized shares. An IPO or another sale of their shares after three to six years of investment offers them the best way to generate that return. Many venture capitalists require representation on the board of directors, specific exit times and / or investor rights to force a "liquidity" event. In comparison, leasing has none of these disadvantages. Venture capitalists typically seek an annual return between 14% and 20%. These transactions generally settle monthly in two to four years and are secured by the underlying assets. Although the risk for the lessor is also high, this risk is mitigated by requiring a guarantee and structuring an amortizing transaction. By jointly using leasing and venture capital, the savvy entrepreneur reduces the total cost of the company's capital, creates value faster for the business and preserves the property.

The business leasing is also very flexible. By structuring an option to purchase or renew at fair market value at the end of the lease, getting started can significantly reduce monthly payments. Lower payments result in increased 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 the transfer of lease charges beyond the expiry of the transaction may offer superior business value to the informed contractor during the initial term of the lease agreement. rental. The increase in the value of the business results from the start-up's ability to generate higher profits, on which most valuations are based.

Customers benefit more from leasing than traditional bank financing in two ways. First, operating leases are generally only guaranteed by the underlying equipment. In addition, there are generally no restrictive financial covenants. Most banks, if they lend to start-up companies, require general liens on all their assets. In some cases, they also require guarantees from new business owners. Increasingly, savvy entrepreneurs are recognizing the stifling effects of these limitations and their impact on growth. When start-ups need additional financing and only one lender has pledged all the company assets or collateral required, these start-ups become less attractive to other sources of financing . Correcting this situation can undermine the time and energy of entrepreneurs.

How the hire-sale works

Generally, large equity capital with credible investors or venture capital investors makes leasing profitable for the start-up company. Landlords structure most transactions as main lines of leasing, allowing the tenant to use the lines as needed throughout the year. Leasing lines typically range from $ 200,000 to over $ 5,000,000, depending on the tenant's needs and creditworthiness. The terms are generally between twenty-four and forty-eight months and are payable in advance each month. The tenant's credit strength, the quality and life of the underlying equipment, as well as the lessor's anticipated ability to re-market the equipment during the term of the lease, often dictate the duration of the lease. initial lease. Although no lessor enters into a lease in the hope of delivering the equipment to the market before the lease expires, in the event of bankruptcy of the lessee's business, the lessor must continue on this path of recovery to save the transaction. Most capital leases provide tenants with flexible end-of-lease options. These options typically include the ability to purchase the equipment, renew the lease at fair market value, or return the equipment to the lessor. Many landlords limit the fair market value, which also benefits the tenant. Most leases require the lessee to assume significant equipment obligations such as maintenance, insurance and payment of required equipment taxes.

Venture capitalists are targeting promising prospects who are likely to respect their leases. Since most start-ups rely on future fundraising to execute their business plans, lenders pay close attention to credit checks and due diligence – valuing the caliber of the investor group , the effectiveness of the business plan and the track record of management. A top management team has generally demonstrated previous successes in the field in which the new company is active. In addition, the expertise of management in the key functions of the business – sales, marketing, R & D, production, engineering, finance – is essential. Although many professional VCs fund new businesses, their capabilities, strength, and resources can vary considerably. The best venture capitalists achieve excellent results and have direct experience of the type of business financed. The best venture capital firms have developed an industrial specialization and many of them have in-house specialists with direct experience of operating in the industries covered. The amount of capital provided by start-up companies and the amount allocated to future rounds of financing are also important for the venture capital funder.

After determining that the management team and venture capitalists are qualified, venture capitalists evaluate the business model of the start-up and the potential of the market. Since most venture capitalists are not technology specialists – able to evaluate products, technology, patents, business processes, and so on. But the experienced lessor undertakes an independent assessment of the business plan and does a due diligence to understand its content. Here, the lessor usually tries to understand the business model and subscribe to it. Issues to be addressed include: Does the business model make sense? What is the size of the market for the services or products of the prospect? Are revenue projections realistic? Is the pricing of the product or service reasonable? How much money is available and how long will it last depending on the forecast? When is the next equity round necessary? Do the key people needed execute the business plan in place? These and similar questions help determine whether the business model is reasonable.

Satisfied with the good functioning of the business model, the funder is primarily concerned with whether the start-up has sufficient liquidity or sufficient liquidity to cover a significant part of the lease term. If the company fails to raise additional capital or lack of cash, the lessor will not be likely to collect additional lease payments. To mitigate this risk, most experienced lenders are looking for start-ups with at least nine months of cash or cash to manage a substantial portion of their leases.

Get the best deal

What determines the price of a lease and how does a potential taker 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 increase in venture capital leasing over the last decade, a handful of national leasing companies are now specializing in venture capital leasing. A good funder has a lot of expertise in this market, is used to working with start-up companies and is willing to help in difficult cash-flow situations, if it were to deviate from its goal. . In addition, the best funders offer other value-added services, such as buying equipment at a better price, exchanging existing equipment, finding additional sources of venture capital, working capital, factoring, temporary CFOs and presentations to potential strategic partners.

Once the start-up has found a capable lessor, negotiating a fair and competitive lease is the next order of the day. A number of factors determine the prices and terms of operating leases. Important factors include: 1] Tenant's perceived credit strength, 2] Equipment quality, 3] Market rates and 4] Competitive factors in the risk leasing market. Since the lease can be structured with several options, many of which influence the ultimate rental cost, new businesses must compare competing lease proposals. Donors generally structure leases for a yield of 14% to 20%. By developing end-of-lease options to better meet the needs of tenants, lessors can transfer a portion of these prices to the rent of the lease in the form of an option at fair market value or less. a fixed purchase or renewal option. It is not unusual to see a three-year lease structured to generate an annual yield of between 9% and 11% over the initial term of the contract. Subsequently, the renter may choose to return the equipment, purchase it at 10% or 15% of the cost of the equipment or renew the lease for an additional year. If the lease is renewed, the lessor recovers 10% to 15% of the cost of the equipment. If the equipment is returned to the lessor, commissioning reduces its cost and limits the amount paid under the lease. The lessor will then put the equipment up for sale in order to reach its performance target of 14% to 20%.

Leasing companies can also justify reducing lease payments by incorporating stock purchase warrants into the transaction. The warrants give the lessor the right to buy an agreed amount of ownership shares at a predetermined price of the action of the parties. In the case of a lease with price on mandate, the lessor usually rents several percentage points less than a similar lease without a warrant. The number of initial offer warrants is obtained by dividing a portion of the line of lease – generally between 3% and 15% of the line – by the exercise price of the warrants. The exercise price generally corresponds to the share price of the last round of participation. The inclusion of a warrant option often encourages venture capitalists to enter into transactions with companies early in development or whose rental equipment is of dubious quality or marketable quality.

Building a young company into an industry leader is in many ways similar to building a state-of-the-art aircraft or bridge. You need the right people, the right partners, the ideas, the materials and the tools. Business Leasing is a useful tool for the savvy entrepreneur. Used properly, this financing tool can help start-up companies accelerate their growth, make the most of their venture capital and increase the value of their business between two cycles of action. Why not preserve the property of those who do most of the work?

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