Working Capital (Debt) Financing For Entrepreneurs: Heather Onstott, Director Of Small Business, LaunchCapital (Part 3)

By guest authors Irina Patterson and Candice Arnold

Heather: I probably look at all three of those three C’s, character, credit, and collateral, but from a slightly different angle in that I am most concerned with making sure that that management team is the right team to bring that business to success, and that I can really get behind the assumptions that are made in the financial projections. That gets to all the basics of market sizing and timing for customer traction and those kinds of things.

I probably dive a bit deeper, and because I have that equity piece, I’m willing to be a little bit more flexible in the repayment structure.

So, going back to our bank example, most banks will provide you a loan – let’s just use $100 because that makes it easy – and over five years, they’re expecting, roughly, $20 of that note to be repaid every year . . .  plus interest.

What happens is, if you lose your job or the business [or], God forbid, there’s an economic downturn or we’re in a recession and sales are down so profitability is down, the bank needs to have that same straight amortization schedule. To be fair, they are very willing to work with you in times of crisis.

We’re able to work with you because at the beginning, a startup is just one big crisis after another. We’re very willing to step in and give some guidance and some mentorship and connect people with who they need to talk to in addition to saying, “OK, you know what, let’s crank back the payment a little bit, and let’s make it up next month.” We’re able to do that because we do have that equity stake. That’s the debt-equity model we have, and we’re experimenting with a debt plus royalty model.

Irina: What is your average loan period?

Heather: Our loans go up to three years.

Irina: What happens at the end of three years?

Heather: With the debt-equity model we have, at the end of three years, the principal and interest of the loan note should be completely repaid. At that point, it kicks into the real return for our firm, which took the risk.

That’s the risk repayment, and that goes in on an equity basis for as long as you want us as an equity partner. You can certainly always buy us out or you can continue to have us on as a silent partner. When you pay dividends to yourself, we get our little pro rata share.

With the royalty structure, it will be a little bit different in that it’ll just be a straight, flat percentage of revenues paid until the cap is hit.

We’ll cap the royalty repayment at a 2x or 3x return, so if, by chance, your company hits it out of the park, and you’re acquired by Microsoft for $100 million, you don’t end up paying $1 million for a $100,000 loan. That’s not really nice.

Irina: What percentage of equity do you usually take?

Heather: We take between 3% and 15%. I don’t, typically, like to take 15%, so for the right companies I have been putting in early buy back clauses. It’s tied to milestones, so if performance milestones are met, we will release part of that equity stake and sell it back to the founder for a dollar.

Irina: That’s for your small business loans, not for your venture deals, right?

Heather: Right.

Irina: At what stage of development can entrepreneurs come to you with their businesses?

Heather: We are seed stage. Seed stage, by definition, is anything from, “I have this great idea” all the way to “I have a great idea; I put it in action; I have blown it out of the water, and now I am a victim of my own success, and I need funding for inventory, receivables, whatever.”

So, anywhere in that early business stage is when we typically get involved. Often times, to be fair, we’ll sit down with an entrepreneur when it’s still just a fuzzy idea and kick things around with them. Sometimes that’s the best success that we have because we’re engaged from the very beginning.

Irina: So, it’s OK to come to you with an idea on paper?

Heather: Sure. Absolutely.

This segment is part 3 in the series : Working Capital (Debt) Financing For Entrepreneurs: Heather Onstott, Director Of Small Business, LaunchCapital
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