It's a competitive world for technology entrepreneurs. Especially in the life sciences and healthcare, venture capital lenders like Horizon Technology Finance can have challenges supporting these ventures in their pre-profit phases.
A careful strategy of relying on experienced founders, a small group of tested partners and banks seems to be working for Horizon.
The U.S. venture debt volume in this area of business reached $17.1 billion in the first six months of 2022, according to PitchBook Data, up 7.5% from the same period in 2021.
Since going public in 2010, Horizon has invested more than $2 billion in VC-backed companies.
Horizon reported $11.1 million in net investment income (NII) in 3Q 2022, and debt issuance portfolio yield of 15.9%, which supported a 10% increase in monthly earnings per share, and special distributions of $0.05 per share in December for the third consecutive year.
In November 2022, Horizon issued $100 million of A-rated Notes backed by $158 million of secured loans originated by Horizon on its lending platform, at an annual 7.56% fixed interest rate that mature on November 15, 2030, completing its final securitization for 2022.
Heading into 2023, Daniel R. Trolio, EVP and chief financial officer of Horizon, based in Farmington, Connecticut, said he expects a big year for the lender.
"There are a lot of opportunities, but there is flight to quality today for all venture debt providers," Trolio said, adding that "it will take a bit longer to get things done."
ASR: How do your lending and securitization returns compare with previous years?
Trolio: Our venture debt portfolio has averaged around 15% in the past few years. In the last securitization we did in November, the cost of debt was 7.56%, so there is a nice interest margin spread, which is good, though not as beneficial as it was in 2019 when the securitization rate was at 4.25%. We are able to maintain a strong spread and benefit from the rate increases. Lastly, the loans we provide are usually floating rate, so as the prime rate increases, our rate will also increase along with the net interest margin.
ASR: Why does Horizon specialize in 144a transactions?
Trolio: We like to work with a tight group of investors and this type of transaction allows us to be more private, as we don't have to do a large marketing exercise. Especially recently, it's hard to get deals done but working with investors that we have a relationship with increases the likelihood of getting them done.
ASR: How do you underwrite unprofitable companies? What are some accounting or management red flags?
Trolio: We focus on companies that are market disruptors changing how things are being done. Also, we look at certain prospective borrower metrics. One of the most important is loan-to-value. We typically provide debt to companies at a LTV ratio of about 20%, on average. There's enough cushion from the enterprise value of the company to allow us to recoup our investment. This cushion will also help the company receive the support of its equity investors and allow us to work together in order to get the company to a soft landing.
In addition, we look at companies with strong management teams that have run new enterprises, and that are sponsored by a strong equity syndicate.
Our borrowers are often burning cash and will need additional investments to service the life of our loan, so strong investor support with the ability to continue investing throughout the venture's life cycle is critical. Horizon's excellent reputation in the market is key as we take a senior position in front of the equity sponsors.
ASR: What is your strategy for diversification?
Trolio: We have the experience and in-depth knowledge to find and manage quality deals not only by industry, but also by sector, which at times are pressured by macro events. We usually have about a 60% to 40% ratio range of our companies in life science to technology, which happens organically. We also look further at sectors such as biotech, medical devices and software and networking technology.
ASR: Reportedly, market growth challenges during the current slowdown include investor preference for seed candidates and early stage startups. How does that translate to opportunities for companies seeking credit?
Trolio: We are definitely in a very interesting time. In the past few years, we saw both record-setting VC fundraising and VC investments. In 2022, that has changed. The amount of capital raised to date already has broken last year's record, so there continues to be a significant amount of investment dry powder.
Equity invested this year declined a bit, but is still strong topping pre-pandemic levels. How it is invested is very different. Investors are telling companies to focus on lowering costs, as they're not looking for 200% revenue growth. Companies that can lower costs while generating slower revenue growth are more likely to get additional funding. Debt opportunities are getting larger for companies that stay private longer, however. It is about matching the risk-reward and understanding the companies. We are looking for companies that are looking at debt because they do not want to raise significant equity at a lower valuation, versus companies that can't raise equity and turn to debt as a last resort.
ASR: Do you expect to see more creativity in VC lending in 2023?
Trolio: I'm always listening to new ideas and looking for creative options. For instance, we added some bells and whistles to our last securitization. We also wanted to be comfortable, ensure the deal would get rated and closed within the time-period we wanted. Otherwise, we considered increasing the advanced rate past two-to-one leverage. That is probably the biggest one that we may have entertained, we have done it with some of our other partners. Outside of that, maybe try to get wider concentration buckets, which would give us more flexibility. Because it opened up so much capacity for us, it made more sense to continue down that path to make sure we completed the transaction in November. I speak to our bankers and know that banks are not trying to get overly creative.
ASR: How involved are traditional banks in venture debt lending? What are the benefits of collaboration for them and for you?
Trolio: Few banks are interested. Silicon Valley Bank and Bridge Bank, however, are among the technology banks that have created a product in our industry, and we partner with them sometimes. The banks offer lower cost of capital, are highly regulated, only fund a certain loan size, and have other restrictions and covenants.
For Horizon, the benefits that at times they can be more efficient on a revolving facility, have back-office infrastructure, and may have relationships with the venture debt provider because that's where the company is banking or has a revolver at the bank. When you work with the banks it's important to have some history with them, know how they operate and how they behave in a downturn market scenario.
