Debt Financing and the Current Market Situation
By Endeavor Greece Apr 19, 2022
Endeavor Greece hosted an AMA session featuring Aris Constantinides, General Partner at Kreos Capital, Andreas Aristotle Dimitriou, Venture Debt Investment Officer at European Investment Bank, and Zaya Kadyrova, Principal at EBRD Venture Capital, Moderated by Apostolos Foteinakis, Chief Financial Officer at Blueground. The panelists discuss their Debt Financing structures, the processes they go through when financing companies, putting themselves in the shoes of those looking into Debt Financing, and how the current market situation and dynamics impact decision making.
Structures that you see in the market and the structures deployed at EBRD
Ms. Kadyrova starts off the conversation by explaining what they offer as a company. They target companies that are at a growth stage, ones that are at a minimum of 10 million euros in annual revenue or above. They also look at having well-established VC investors/equity investors at the cap table as criteria that they focus on.
Due to the fact that they are equity first investors, venture-debt for them is an option for companies that they feel as though offering an equity investment is a little too late or the equity updates are limited. Given how their company operates, in regards to structure, there is an interest component so this debt is repaid either monthly or quarterly. Interest depends on a case-by-case basis. There is also a warrant component, where the standard is an 8-10 warrant coverage – meaning that 8-10% of the loan is allowed to convert to equity in the last round.
Mr. Constantinides tackles the same question and explains that Kreos Capital has essentially evolved with the market as they have been doing this for a long period of time and from experience have divided the process into 3 buckets. There is a wide range of borders, and what they like to do is follow companies on their growth trajectory, and like to invest in them and provide more capital when they see fit.
Entry-stage bucket: Companies that are just starting their growth trajectory. In this case, they would provide the type of debt known as venture debt. This is essentially a 3-4 year loan, with interest rates around 9-10 percent, a warrant coverage, and a relatively modest interest-only period. The size of the loan would be around 5-10M Euros.
Mid-stage: has grown from entry-stage and ideally is in a couple of markets, has 20-30M in revenue and it’s a company where we can provide growth debts which can be a little more flexible, long interest loaning periods, with lower warrant coverage. In these cases, there is much more flexibility and they tend to lend around 20-30M euros.
Late-stage PLUS companies: the category where companies have grown into significant businesses, still not profitable, but growing at 60-100 per annum. Here they can provide a significant amount of capital by writing 50M + cheques and above. It’s important to note that as the company matures, there can be more and more flexibility.
Mr. Dimitriou from EIB also touches on an approach, similar to that of the other participants, which are more or less dividing their potential investments into three buckets.
“The investment strategy follows three pillars horizontally and vertically regarding the type of R&D and what the company does vs timing and revenue structure”
Andreas Aristotle Dimitriou
Pre-revenue companies: Don’t have any revenue but have a significant amount of capital. These are usually biotech companies, the reason being that you either invest before revenue or after they have the FDA approval.
Early growth companies: Ones that usually have a couple million in revenues with a proof of concept being there, and a few clients and they want to grow.
Late-stage companies: Ones that have 10-20M in revenues already, they are proven national players in what they do, they want to grow in international markets. Here EIB would usually give a minimum of 7.5M tickets. Due to the fact that they are a policy bank, they usually need to find a project to finance and therefore need to find some R&D investment over the next 3-4 years. It’s necessary to conceptualize that there is some research and development in the product, in the long run. This can also be considered a limitation from the policy aspect, but financially they also look at some early-stage companies that are fast-growing and can provide them tickets that could be equal to their revenue at the time.
“When is the right time to raise debt and what is the right time for companies to think about raising debt?”
What Ms. Kadyrova advises, from experience working with equity portfolio companies, is to have conversations around venture debt, if that’s something that’s in the cards shortly after they have raised their equity round. She said that by doing this you can easily negotiate and start having conversations about term sheets, almost allowing you to secure an optionality for yourself. Though case-specific, they do recommend it shortly after having their last equity raise.
Mr. Constantinides takes on this question by emphasizing a previous point of his, stating that there’s a right and wrong time to take on debt that will affect the outcome and growth of the business. He says that the discussions that they have with C-level executives from the companies we invest in now, are way different than the ones we used to have in the past with respect to understanding the use of debt.
“We are not a substitute for debt”
If you cannot raise equity or get appropriate financing from equity investors, they are not the right investors for you. Debt is an additive to equity, meaning if you can’t raise equity and you’re looking to fill a gap, then debt financing is not for you.
A Synergistic Approach
In regards to a company’s performance, business plans are often rewritten numerous times due to changes within the company, market, and the product itself. There are very understandable business risks associated with those changes, that the Kreos Capital looks at. Kreos Capital works proactively and has created a business model that relies on the portfolio company they are looking at investing in, to have raised money from institutional equity investors for Kreos Capital to be involved.
“It’s important to acknowledge upfront that companies run into challenges”
He goes on by saying that the way they approach potential risks the company could run into is by developing a relationship with the company itself and its sponsors/investors. “We see it as a three-legged stool,” he says. Things can be restructured with payments if the company is going through troubles, knowing that they have an institution that is backing them. Creating a synergistic and symbiotic relationship with the equity and management team to help the company out of difficult situations is key!
They also like to take board observation rights, not necessarily a board seat, but they like to stay close to what the company does and to understand their business needs. This way they can also anticipate problems and help in advance if needed. You need a company that’s flexible and that’s what they try to be by making synergy part of their DNA.
The market and pieces of advice for companies
Ms. Kadyrova goes on to say that overall in Europe you can feel the effects of the global issues on the ecosystem. That includes but is not limited to the effects of COVID19 as well as the war in Ukraine.
“Overall advice we portfolio companies (wearing the equity hat) is – prepare yourself for uncertainties”
It may take a little longer to raise funding, you have to be nimble and cautious which means preserving your resources if you can. Then again it’s not the same message they gave in 2020 where everyone was advising people to cut down costs and prepare for the worst.
Though Debt Financing is still an unexplored area for the majority of entrepreneurs, with this conversation we were able to understand the different options offered to companies at various stages and pinpoint opportunities to find the silver lining in financing their companies.