Venture debt is a loan to a high-growth (and higher-risk) company that faces a cash squeeze but doesn’t qualify for bank lending. Private equity and mezzanine funds such as Roynat Capital have been providing convertible debt (loans with an equity component) to bigger firms for years, but the deal becomes venture debt when it’s done with an early-stage company with little or no revenue.
Venture debt was brought to Canada by Minhas Mohamed, a fund manager for Quorum Group, a Toronto-based supplier of private expansion capital. In 1997, one of his investee companies needed $5 million to get to a certain milestone, but arranging another equity round would have taken too much time and effort and required a valuation no one wanted at the time. Mohamed found a solution in a U.S.-based lender of venture debt. It was that lender’s first Canadian deal, but it worked very well. The client company hit its milestone, says Mohamed, and was sold soon after for about twice as much as it would have been had it accepted another round of venture capital.
Mohamed soon quit his job to team up with the U.S. lender to bring venture debt to Canada. Focusing mainly on IT and life-sciences firms, they did $150 million worth of deals in five years. In 2003, Mohamed formed MMV Financial, raising enough capital from other investment funds to finance $300 million of deals. In 2005, MMV invested US$54 million in 22 firms, with most deals falling between $1 million (the minimum size it will consider) and $5 million.
Since venture debt requires less due diligence than venture capital, it is fast. But it’s not cheap. MMV charges about eight points above prime — or a recent 13.5%. To get that venture sparkle, it also insists on receiving warrants that could amount to 2% to 3% of the firm’s overall value. Compared to the pain of diluting your equity base through another round of venture capital, however, 13.5% can look pretty good. But don’t feel sorry for the VCs: they call in MMV when they’re trying to avoid dilution in their own portfolio companies.