VentureOne and Ernst & Young's quarterly venture capital report show that in 2003, venture capitalists and investors allocated more than $18 billion to promising young US companies. Less recorded and reported is the activity and quantity of risk leasing. This form of equipment financing has greatly contributed to the development of US start-ups. Each year, professional leasing companies invest hundreds of millions of dollars in start-ups, allowing savvy entrepreneurs to achieve maximum "revenue" in financing growth. What is risk leasing? How can sophisticated entrepreneurs maximize corporate value through this financing? Why is risk leasing able to finance the equipment needed in a cheaper, smarter way than venture capital? As an answer, we must pay close attention to this relatively new and expanding form of equipment financing, designed specifically for fast-growing venture capital-backed start-ups.
The term risk leasing describes the leasing of equipment to start-ups funded by venture capital investors. These companies typically have negative cash flow and rely on additional equity rounds to achieve their business plans. Risk leasing allows growing start-ups to get the operational equipment they need while saving on expensive venture capital development funding. Equipment for risk leasing financing typically includes essentials such as computers, laboratory equipment, test equipment, furniture, manufacturing and production equipment, as well as other equipment for office automation.
It is wise to use risk leasing
Risk leasing has many advantages over traditional venture capital and bank financing. Financing new businesses can be a high-risk business. Venture capitalists often require companies they fund to hold substantial equity to cover this risk. They usually seek a return on investment of at least 35%-50% on their unsecured, non-amortized equity investments. An initial public offering or other equity sale within three to six years of investment provides them with the best way to get this return. Many venture capitalists need board representatives, specific exit time frames and/or investor rights to enforce "liquidity" events. In contrast, risk leasing does not have these shortcomings. Venture capitalists usually seek annual returns in the range of 14%-20%. These transactions are usually repaid monthly for two to four years and are guaranteed by the underlying assets. Although the risks of venture capitalists are high, this risk can be mitigated by transactions that require mortgages and build amortization. By combining venture capital and venture capital, savvy entrepreneurs reduce the overall cost of capital for venture capital, building corporate value faster and retaining ownership.
Risk leasing is also very flexible. Startups can cut monthly payments by building a fair market value purchase or renewal option at the end of the lease. Lower payments result in higher revenue and cash flow. Since fair market value choices are not obligations, tenants have a high degree of flexibility and control. The resulting reduction in payments and the transfer of lease fees beyond the transaction period can provide a higher corporate value for savvy entrepreneurs during the initial lease period. Higher corporate value comes from the ability of startups to achieve higher returns, and most valuations are based on this.
Compared with traditional bank financing, customers benefit more from risk leasing in two ways. First, risk leasing is usually only guaranteed by infrastructure equipment. In addition, there is usually no restrictive financial contract. Most banks need to fully retain the assets of all companies if they provide loans to early companies. In some cases, they also ask for the person in charge of the startup. More and more sophisticated entrepreneurs recognize the stifling effects of these restrictions and their impact on growth. These young companies are less attractive to other sources of financing when start-ups require additional financing and the only lenders have blocked all company assets or required guarantees. Correcting this situation may weaken the entrepreneur's time and energy.
How does risk leasing work?
In general, a round of major equity capital raised from a trusted investor or venture capitalist makes risk leasing feasible for early adopters. The lessor constructs most of the transactions as the main lease line, allowing the tenant to divide as needed throughout the year. Lease lines typically range in size from $200,000 to $5,000,000, depending on the tenant's needs and credit strength. Terms are usually paid between 24 and 48 months, and paid in advance each month. The credit strength of the lessee, the quality and useful life of the equipment in question, and the expected ability of the lessor to re-sell the equipment during the lease usually determine the initial lease term. Although no lessor enters the lease arrangement, it is expected to re-equip the equipment before the lease expires, but if the lessee's business fails, the lessor must take this recovery path to save the transaction. Most risk leases give the tenant a flexible lease term option. These options typically include the ability to purchase equipment, renew leases at fair market value, or return equipment to the lessor. Many lessors limit the fair market value, which also benefits the lessee. Most leases require the lessee to assume important equipment obligations, such as maintenance, insurance, and equipment taxes required for payment.
The risk tenant's goal is the tenant's prospects, which have a good commitment and may fulfill their lease. Since most start-ups rely on future equity rounds to execute their business plans, the lessor places great emphasis on credit review and due diligence – assessing the capabilities of the investor community, the effectiveness of the business plan, and the management's background. Good management teams often achieve previous success in areas where new businesses are active. In addition, management's expertise in key business functions - sales, marketing, R&D, production, engineering, finance - is critical. Although many professional venture capitalists finance new businesses, their capabilities, endurance and resources may vary widely. Better venture capitalists can achieve excellent results and have direct access to the experience of the funded companies. The best venture capital firms have developed industry specializations. Many venture capital firms have in-house experts who have direct operational experience in the industry involved. For venture capitalists, the most important is the amount of venture capital to provide start-up capital. And the amount allocated to future financing rounds.
After determining whether the management team and the venture capitalist are qualified, the venture capitalist will assess the business model and market potential of the startup. Since most venture capitalists are not technical experts - able to evaluate products, technologies, patents, business processes, etc. - they rely heavily on thorough due diligence by experienced venture capitalists. However, experienced venture capitalists did conduct an independent assessment of the business plan and conducted careful due diligence to understand its content. Here, the lessor usually tries to understand and agree to the business model. Questions to answer include: Is the business model reasonable? What is the market for potential customers' services or products? Is the income forecast realistic? Is the pricing of the product or service reasonable? According to the forecast, how much cash is there and how long? When do you need the next round of equity? Do key personnel need to implement a business plan? These and similar questions help determine if the business model is reasonable.
Satisfied with the reasonableness of the business model, the most concerned about venture capitalists is whether the startup has sufficient liquidity or cash to support a large part of the lease term. If the joint venture fails to raise additional funds or exhausts cash, the lessor is unlikely to receive further lease payments. To reduce this risk, most experienced venture capitalists look for start-ups with at least nine months of cash or sufficient liquid assets to serve most of their leases.
Get the best deal
What determines the risk of leasing pricing and how the potential tenant gets the best deal? First, make sure you are satisfied with the rental company. This relationship is usually more important than transaction pricing. With the rapid increase in risk leasing over the past decade, a few national leasing companies are now focusing on risk leasing. A good venture capitalist has a lot of expertise in this market, is accustomed to working with start-ups, and if start-ups deviate from the plan, they are prepared to help deal with difficult cash flow situations. In addition, best-invested investors offer other value-added services – such as assisting equipment acquisitions at more favorable prices, trading existing equipment, finding additional sources of venture capital, working capital, factoring, temporary CFOs, and introducing to potential strategic partners.
Once a startup finds a capable venture capitalist, negotiating a fair and competitive lease is the next business order. Many factors determine risk rental pricing and terms. Important factors include: 1] the tenant's perceived credit strength, 2] equipment quality, 3] market interest rates, and 4] competitive factors in the risk leasing market. Since leasing can be built through a variety of options, many of which affect the final rental cost, startups should compare competitive leasing options. The lessor typically uses a structured rental yield of 14% - 20%. By developing the lease term option to better meet the tenant's needs, the lessor can transfer part of the pricing to the back end of the lease in the form of fair market value or fixed purchase or renewal options. During the initial lease term, it is not uncommon for the annual structure rate of three-year leases to be 9%-11%. Thereafter, the tenant can choose to return the equipment, purchase 10% - 15% of the equipment cost or renew the lease for one year. If the lease is renewed, the lessor will recover an additional 10% - 15% equipment cost. If the device is returned to the lessor, the startup will reduce its cost and limit the amount paid under the lease. The lessor will then remarket the equipment to achieve a 14%-20% production target.
Another way in which a leasing company can prove to reduce leasing payments is to include warrants in the transaction. The warrants give the lessor the right to purchase an agreed number of ownership shares at a predetermined share price. According to the risk leasing of the warrant pricing, the lessor usually has a lease price that is less than a few percentage points of the similar lease without the warrant. The number of warrants for starting capital is obtained by dividing a portion of the lease line [usually 3% to 15% of the line] by the warrant execution price. The strike price is usually the stock price of the most recently completed stock round. Including warrants typically encourages venture capitalists to trade with early-developed companies or companies that have a problem with the quality of the equipment they are renting or can resell.
Turning a young company into an industry leader is similar in many ways to building the most advanced aircraft or bridges. You need the right people, partners, ideas, materials and tools. Risk leasing is a useful tool for savvy entrepreneurs. When used properly, this financing tool can help companies in the early stages accelerate growth, squeeze out the most from venture capital, and increase corporate value among equity rounds. Why not retain the ownership of the person who really does the heavy thing?
Orignal From: Risk leasing - a smarter way to build enterprise value
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