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Filling the venture debt gap
Our mantra is to serve the underserved, and that's where one of our products – venture debt – comes in. We see an underserved market for venture debt in the UK.
We're seeing a lot more founders and CFOs exploring options around fundraising, who are looking to be as efficient as possible in their financing strategies.
There is an increasing trend in parties wanting to bring in debt alongside equity to get them through to that next stage of their company's investment cycle.
At Shawbrook we are sector agnostic and will explore deals on a case-by-case basis, looking at what the product is, the size of the market, the investment case and the level of equity support.
There is a larger focus on B2B businesses that are providing 'mission critical' software or technology to end customers, as opposed to consumer-led businesses.
From Shawbrook's perspective, we look at businesses that are at the Series A fundraising stage through to Series B.
With Series A-stage companies, they typically have the scale and level of revenue that supports servicing debt, so we typically look to see revenues of at least £2 million over the last financial year.
The venture debt process
As a general rule, we will explore each deal on its own merits and look at the risks and mitigating aspects to those risks.
We will typically start by receiving an equity case for the business, to understand what they are trying to do.
We will then design a base case that we can track our covenants against, which is typically more sensitised than the equity case, showing strong revenue growth but at a slightly slower pace than predicted by the business.
Then we run two further scenarios – a downside case where revenue doesn't grow as expected, and a run for cash scenario, looking at what the business would need to do in the worst case to switch off costs and run the business for cash to service the debt.
We work very closely with our clients; it's about keeping up with their strategy and how their growth profile is transitioning, because those forecasts are rarely set in stone.
Provided that the borrower instigates the conversation with us early enough, we are typically willing to look at re-forecasts, as opposed to holding them to something they may have signed six to 12 months ago when it was a slightly different macroeconomic picture.
I think this is important when a business is looking for a venture debt partner to ask for examples from that lender of how they have behaved and treated businesses when there has been a downturn, or slowdown in revenue.
The metrics
There are key metrics that we will look at to decide whether a business proposition is for us.
These include revenue, i.e. £2 million+ in revenue from the previous financial year; growth rate, where we'll want to see historic growth rate of around 20% on average per annum; and route to profitability (i.e. what is the company's strategy to become profitable in the next 18 months or so).
We then look at the investor base. We are looking to see that there is a reputable venture capital firm that has invested and are supportive of the company.
We might also look a bit wider, for example at angel syndicates and structures when considering the total equity raised. We'll also look at strategic investors, such as corporate investors.
The final thing we're looking for is whether this business is mission critical to its customers and is there a tangible opportunity.
The pitch
The first step for us is to have an initial introduction with potential clients, which is usually around 30 minutes. We'll ask them to introduce the offering and explain more about the business, and where they plan on taking it.
Typically we'll ask for four key documents to give us an indicative steer on what a debt facility could look like.
Those four documents are (i) the investment memorandum, (for example on their latest investment or debt round); (ii) the annual accounts; (iii) latest management information; and (iv) the financial model or equity case.
Provided that these four key documents are readily available to us, it can be a seamless process to understand the business and what we can do from a debt perspective.
All this gives us the ability to decide whether venture debt is the right product for the business.
The areas where we would consider that venture debt is not the right solution is where the business is looking for a 'lender of last resort', for example if the investors are no longer supportive.
Another inappropriate case is where we are asked to put debt in to fund paying cash out to shareholders.
The debt structure
A key area to concentrate on when you are looking at an indicative proposal or a first stage term sheet is whether the lender is able to provide the amount you need to achieve what you're looking to do. This should be discussed at the initial stage.
You also need to think about how the draw-downs are structured and the overall repayment structure – how long is it and does it support your route to profitability or next equity?
Then there are covenants, which are effectively a financial forecast the lender will track against pre-agreed metrics. There are a variety of covenant structures out there from lenders and funds. Covenants are only suitable for businesses that are confident they can hit their forecasts, other businesses might fare better without them – at least at an early stage.
In general, businesses need to consider their ability to meet targets set under venture debt agreements and the best thing is full transparency, so if there are any challenges lenders will want to know about them early and have those discussions early, to plan and support the business.
The same goes for transactions such as strategic investment or M&A.
I like to think we can move very quickly for businesses and help them achieve what they want to achieve.
Overall, it's about understanding what sustainable growth looks like for the business and what capital is needed to achieve that.
It's then about exploring venture debt and what structures suit a business' aims – as this is still a relatively young market, businesses can often find a structure and lender to suit their particular business need.
Jack Bates was in conversation with Fieldfisher Corporate Associate Josh Cronin, as part of London Tech Week 2023.