Each year, venture capitalists finance more than 2,500 startups in the US Many of these companies try to preserve their equity capital by approaching venture leasing firms to secure equipment financing. By obtaining lease financing, these savvy businesses can use their equity capital for high-impact activities such as hiring key personnel, product development, and expanding their marketing efforts.
What are the qualities that make some startups more attractive to venture capitalists than others? Here are ten factors that most venture lessors look at when deciding which startups to finance:
Caliber of management team
Most business landlords consider the start-up management team to be the most critical success factor for the business. Although it can be challenging to quickly assess management talent, there are several qualities that venture capitalists consider. They seek experienced managers with high integrity and a proven track record of business performance.
Quality of Venture Capital Sponsors
Another important factor for most venture capitalists is the quality of the startup’s venture capital sponsors. Venture capitalists seek experienced venture capitalists with a successful investment return over several years. Venture capitalists must also have a good reputation for dealing fairly with creditors servicing their portfolio companies. Before entering into new lease agreements, most venture lessors check to see that the startups’ venture capital backers are actively supporting them.
Solidity of the Business Plan
Successful startups often have compelling and well-articulated business plans. Lessors look for signs that new businesses have promising market opportunities, clear and credible projections, and reliable financial statements.
Cash position/monthly consumption rate
One yardstick used by many risk lessors to measure risk is the startup’s projected cash burn rate. The ratio of cash on hand to the start-up’s monthly consumption rate is a useful measure. It crudely determines how long the startup can last before a new round of actions is needed. The lessor considers a transaction to be less risky if the start-up can make full payments over a significant portion of the lease term without raising additional equity capital. Most lessors look for a relationship that supports at least 9-12 months of start-up operation.
team quality
The quality and intended use of the equipment is an important factor for most venture lessors. Most lessors look for transactions involving equipment that is essential to the operation of the start-up. In addition, the equipment must have an acceptable warranty value and be easily resalable on the secondary equipment market.
Revenue Tracking History and Product Sales Opportunities
If the startup is in the development stage and has yet to sell products, venture capitalists generally look for products capable of establishing a strong position in the market. If the start-up proceeds are already in distribution, lessors are looking 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 faulty product concept.
Valuation history
A valuation history records the prices of shares sold to investors by the startup. Unless there is a good explanation, most lessors look for significant share price appreciation in successive offering rounds. The assumption is that the startup is making steady and significant progress in its development, which will be reflected in rising stock values.
Balance Sheet Strength
Venture lessors typically assess a new business’s working capital to ensure that the new business can make payments when due. Along with a start-up consumption rate analysis, lessors use traditional working capital measures such as current and quick ratios. Lessors also look for other signs of balance sheet strength, such as: low to moderate leverage; positive tangible net worth (including subordinated debt); and minimum paid-in capital of $7 – $10 million.
External professional participation
Most venture lessors see the involvement of reputable and successful outside board members as a positive factor for start-ups. Landlords also view reputable CPAs, law firms, institutional partners and/or service providers as positive. These professionals can bring valuable experience and contacts that can help the new business succeed.
payment performance
As with more traditional tenants, leasing companies frown on tenants’ poor payment histories. Most venture landlords expect tenants to have a satisfactory payment history unless good explanations can be offered. Like other providers, successful payment of invoices by customers is where the rubber meets the road. Whether the tenant is a start-up or a Fortune 500 company, most landlords view prompt payment as sacrosanct.
Although risk lessors use additional factors to make their credit decisions, these ten factors appear to be used universally. Although most of these factors are subjective, they have stood the test of time for risk lessors to make informed and reasonable credit decisions.