Venture capital firms are increasingly tapping venture debt as a part of their financing toolbox for later-stage start-ups.
The prolonged economic recovery and delay in exit times for portfolio companies have compelled VCs to infuse significant dollars into late-stage start-ups to keep them going until IPO or M&A.
And that's a trend that's providing a growth opportunity for Farmington-based Horizon Technology Finance Corp.
"When VCs want to create more value in a company prior to an exit, venture debt is the perfect option," said Gerald A. Michaud, president of Horizon Technology Finance Corp. (Nasdaq: HRZN).
Horizon's team of 16 employees provides secured loans to venture capital and private equity-backed companies in the technology, lifescience, healthcare, information services and clean-tech industries.
Venture debt is typically sought by high-growth, later-stage companies that need more capital and are positioned to achieve milestones within a year or two. Financing is usually for a period of up to four years and is extended to development-stage start-ups that are close to posting earnings, raising an additional round of venture capital or going public.
For some later-stage start-ups, venture debt is a more attractive alternative to bank loans, which come with many regulatory caveats. Unlike equity financing, venture debt enables entrepreneurs to retain ownership of their start-ups and leverages a firm's fixed assets. When milestones are reached through debt financing, the start-up is in a better position to secure additional venture capital and create higher valuations prior to going public. Big-name brands that took on venture debt include Facebook, Google, YouTube and Etsy.
Latest data from Thomson Reuters and the National Venture Capital Association shows that 19 venture-backed companies nationwide went public during the first quarter of this year, raising $1.5 billion. This represents a 10 percent increase in dollar terms from the first quarter of 2011. From January through March of this year, companies reported 86 venture-backed M&A deals of which 24 had an aggregate deal value of $2.7 billion.
Fund flows in the venture debt industry are not tracked like in the venture capital industry. But the number and size of deals reported by individual companies in the past six months indicate that entrepreneurs are showing a steady appetite for venture debt. Firms have successfully raised capital for new funds. For example, California-headquartered TriplePoint Capital, a leading venture debt firm, raised the largest venture debt fund last October, totaling $1 billion.
Horizon closed a $30 million senior note financing this March and will deploy the funds in maintaining and expanding its portfolio of companies. Investment activity rose steadily through the past three quarters from $7 million in the third quarter of 2011 to $19.5 million in the fourth quarter of 2011 and $31.7 million in the first quarter of this year.
Horizon started operations in 2003 and has provided more than $800 million in loan commitments to date. Michaud said total loan losses on cumulative investments have been less than 1.5 percent.
"It's is a well-managed company. I know a number of VC-backed later-stage start-ups that have worked with Horizon in the past and they've have had a very good relationship," said Victor R. Budnik, managing director at Ironwood Capital in Avon. Budnik was a former president at Connecticut Innovations.
For now, the majority of Horizon's investments are outside Connecticut in Massachusetts, Maryland, Washington, D.C. and Virginia.
"Most of our business comes from VC referrals and is generally based on proximity to MIT and Harvard — much of the technology comes out of there," Michaud said.
"We expect 2012 to be a good year for exits. There will be M&As with significant warrant gains," Michaud said.
Horizon's past investments that morphed into successful acquisitions include Motorola's acquisition of Good Technology, IBM's acquisition of Softek and Amgen's acquisition of Alantos Pharmaceuticals. All of Horizon's investments are in start-ups backed by big-name VCs such as the Carlyle Group, Bain Capital Ventures and Canaan Partners.
Start-ups that received loan funds from Horizon during the first quarter of this year include Boston-headquartered digital commerce services company Optaros, Inc., which received $ 2 million. Optaros' clients include Walmart and Puma.
Horizon loaned $12 million to Connecticut and Ohio-headquartered Radisphere National Radiology Group, Inc., an existing portfolio company, which works with rural and community hospitals to improve patient care while reducing costs.
Horizon's investments range from $2 million to $25 million and the terms for senior loans are between 24 to 48 months.
"We're very excited about 2012. We're seeing a lot of early-stage companies just getting their products to market and are also seeing some really great late-stage opportunity just before they go public," Michaud said.
At a Glance
Horizon Technology Finance Corp. (NASDAQ:HRZN)
First Quarter of 2012
• Net investment income: $3.4 million or $0.44 per share. Since its IPO in October 2010, Horizon has reported realized gains of about $6.9 million, or $0.91 per share.
• Weighted average yield of portfolio: 15.4%
• Investment portfolio at end of quarter: $167.3 million and net asset value of $129.0 million
• Quarterly dividend yield: $0.45 per share
• Share price as on May 9: $16.75
• 52-week high /low: $17.31 / $12.24
• Shares outstanding: 7,640,000
• Market value: $ 127,970,000
• P/E ratio: 11.63