NEW YORK, June 15 (LPC) - Venture lending business development companies (BDCs) are becoming increasingly active in the private credit space as the coronavirus pandemic continues to weigh down more traditional sources of lending for small and mid-sized companies.
A handful of firms, including Hercules Capital, Horizon Technology Corp and TriplePoint Venture Growth are targeting fast-growing late-stage companies, generating outsized returns compared with traditional middle market private credit.
Unlike banks that are usually more conservative with their investments, these BDCs provide debt to startups and growth companies that do not have positive cash flows or significant assets to use as collateral.
The life sciences and the technology sectors, favored by venture capital (VC), are also favorites of this type of venture lenders.
Hercules, a BDC with a US$1.1bn net asset value (NAV), recently committed to a US$100m debt package for oncology company G1 Therapeutics to fund its development of trilaciclib, a drug designed to assist patients through chemotherapy. Horizon Technology Corp has reported a spate of deals in the last month, including a US$15m loan package for Emalex Biosciences to fund clinical trials for its Tourette syndrome treatment drug.
“We feel good about the life sciences marketplace right now. There is plenty of capital flowing into that market,” Jerry Michaud, chief executive officer at Horizon, said in a telephone interview.
Because venture debt combines loans with warrants, or rights to purchase equity, to compensate for the higher risk of default, it can also provide double-digit returns.
The debt is provided at a higher price tag compared with traditional private credit financing and is typically a shorter duration, with maturities set between 36-48 months.
Funding is usually contingent on milestones reached by the borrowing companies, whether it is regulatory approval for a drug product or a certain level of sales.
Loan-to-values (LTV), a standard risk assessment measure, are typically in the 10%-30% range for venture capital debt, according to Michaud, significantly lower than middle market private credit deals that can range 60%-80%.
In the recent first-quarter earnings season, Hercules, Horizon, and TriplePoint, all publicly traded BDCs, reported a modest decline in their respective NAV per share, compared with the 14% average drop for the industry, according to Refinitiv BDC Collateral.
Non-accruals were low, and debt-to-equity ratios hovered around the one times level, also lower than the industry level average of 5.5%.
Unlike shares of other BDCs that target the middle market, the stocks for Hercules and Horizon trade above NAV, which suggests investor confidence in venture lending.
The high NAVs are boosted by the fact venture capital firms are sitting on record sums of capital that can be deployed to help companies and finance new investments.
“There were measures taken by portfolio companies to cut costs and bolster the balance sheet, and that goes hand in hand with the fact that they are generally backed by multiple VCs,” said Tim Hayes, an analyst at B Riley FBR, in a phone interview. “There is a ton of VC capital sitting on the sidelines to support portfolio companies.”
In 2019, venture capital funds raised US$46.3bn in 2019, the second-highest total since 2018’s record year of US$58bn, according to data from research firm Pitchbook and trade body National Venture Capital Association.
In its first-quarter earnings call, Hercules reported a fifth of its portfolio companies were able to raise new equity or subordinated capital from outside sources.
“What we’ve seen so far is decisiveness and action preserved to protect balance sheets, extend runways and ensure that the companies have enough balance sheet liquidity to survive an extended period of uncertainty and volatility,” said Scott Bluestein, chief executive officer at Hercules, in the firm’s first-quarter earnings call last month.