Opinion article published by El Referente, written by Iván Moll
Like almost everything related to venture capital, venture debt (“VD”) was born in the United States as a new form of financing for emerging companies and startups, which allows them to obtain funds by granting a loan with a financing cost, in theory, lower than that of equity, paying, however, a higher interest rate than that corresponding to traditional loans.
Furthermore, as is well known, the DV loan is accompanied by a warrant that gives the lender the option to assume/subscribe equity at a certain price, providing a return in addition to the interest on the loan itself.
Recently, the DV system has been proliferating in Spain and more and more traditional financial institutions are offering this product. However, they are offering it, in my opinion, distorting or distorting its concept, which is defined by its own genesis as mentioned above, fitting it, as unfortunately it cannot be otherwise, into the tradition and customs of the omnipresent and all-powerful Spanish financial system. I cannot expand on this due to the requirements of the script, so I will summarise some of the aspects which, as I have said and in my opinion, cause this distortion, but there are others.
The financial institution lending to VCs lacks the culture of a player in the venture capital system, either because of a lack of knowledge due to tradition or because it is unwilling or unable to have it, in some cases, I suspect, as a result of the risk control requirements derived from the regulations applicable to financial institutions and groups. The DV offered by traditional financial institutions cannot be the result of adding a traditional loan, with a high interest rate, plus a warrant. In DV loan contracts, there cannot be, in my opinion, obligations for the company that are contradictory to the emerging nature of the company itself, to its financing system through the execution of financing rounds or to the ultimate goal pursued by many (or by all), which is the exit, i.e. its acquisition or IPO. We see this, for example and among others, in mandatory redemption regimes arising from aspects such as market failure or lack of funding on the interbank market for borrowed funds or with contractual regimes of prior consent of the lender for the implementation of share capital increases and, Consequently, financing rounds, for the sale of assets, for transactions involving a change of control, for the acquisition of complementary businesses, for the implementation of joint ventures or, what a barbarity, for the assumption of subordinated debt such as for example arising from convertible loans granted by partners. Likewise, it goes without saying that, as it is clearly impossible, it is absurd and disproportionate to require the validity of the representations and guarantees granted at the signing of the DV contract during the very term of the financing contract, ignoring the requirements of agility, not only operational but also structural, of this type of company and even of its business. The above, as I have said, are just a few examples of, let me put it this way, misalignment of the product on offer with the rationale for its existence.
Another aspect of denaturalisation is, in my opinion, the unwillingness of the financial institution granting a DV loan to assume the risks inherent to the business and the company’s venture. We know that there is a risk, not negligible, of non-payment of the loan, but for this reason, it is common to demand and propose in DV loans, real guarantees, normally on IP or the senior and non-subordinated nature of the credit or the application of a higher interest rate than traditional loans. We see the lack of willingness to assume the risks inherent to the business and the company when, in addition to the aforementioned guarantees and obligations, disproportionate information and reporting obligations are demanded which, in most cases, due to the start-ups’ own management and resource structure, are impossible to assume or, another example, in the implementation of a system for transferring risks to the company, with compensation obligations which, in relation to the above and despite the more than presumable prior knowledge of the lender, must be assumed by the company. We see the lack of willingness to assume the risks inherent to the business and the company when, in addition to the aforementioned guarantees and obligations, disproportionate information and reporting obligations are demanded which, in most cases, due to the start-ups’ own management and resource structure, are impossible to assume or, another example, in the implementation of a system for transferring risks to the company, with compensation obligations which, in relation to the above and despite the more than presumable prior knowledge of the lender, must be assumed by the company.
Finally, with regard to the warrant contract, it is common to observe, in my experience, how the exercise price set by the lender of the DV, since the warrant is configured as an option, is the nominal value of the units or shares instead of what is proper and standard in the genesis of the DV, which is the market price or fair value (although they are substantially different concepts) of the unit at the time of formalisation of the warrant contract, applying or not a discount, for example, the price per unit paid in the last round of financing executed by the company. By setting the nominal value, in my opinion, a hardly justifiable gain is granted.
Likewise, in the repeated lack of awareness of the venture capital system suffered by some financial institutions that grant DV loans, we see how they demand to be holders of a series of political and economic rights, not only when exercising the warrant, but in many cases during the term of the financing and therefore independently of said exercise, with total disregard for what is established in the company’s current or future shareholders’ agreements, causing a systemic imbalance and disorder in the company’s governance, for example, demands for participation in the distribution of dividends, vetoes in the general meeting and the board of directors or exit clauses at the company’s discretion, with the company having to buy back its shares at least at the price per share of the last financing round.
