• Venture Debt Giant WTI on Good Times, and Dangers Ahead

    maurice-werdegarThe 34-year-old venture debt firm Western Technology Investment (WTI) has seen some cycles, and its CEO, Maurice Werdegar, thinks investor Bill Gurley had a point when he talked publicly last week about the excessive risk that startups are taking on.

    He doesn’t think Gurley scared anyone straight, though. “I think the [dot com bubble of the late ‘90s] is a distant memory to many participants in the ecosystem, so we’re not seeing anyone panic or ring the alarm bell,” says Werdegar. “We’re seeing burn rates increase across the board, and that’s emblematic of companies that think they’re supposed to accelerate into their opportunity without thinking about whether they can raise the next round.”

    It can mean brisk business for venture debt companies like WTI, which is currently joining about 100 financing deals a year, but it’s also dangerous, notes Werdegar. We talked about the environment, and WTI’s role in it, yesterday morning. Our chat has been edited for length.

    For readers who don’t completely understand venture debt, can you explain why a startup would turn to you?

    There are a number of cases, including to finance equipment, like when it comes to bitcoin mining. When a startup is behind on its plan, venture debt can also give it time to achieve the milestones it needs to obtain. Or it can be used to provide more runway to a company that may be hiring and spending ahead of its original plans because it sees a product-market fit and doesn’t necessarily want to be forced into raising another [VC] round prematurely.

    Another case is to get to profitability. Sometime companies close enough to achieving breakeven raise debt rather than raise capital again, which can change acquisition discussions. Some startups also turn to venture debt to take out a competitor. Maybe they didn’t contemplate an acquisition when they raised their last round; venture debt [enables them to acquire that competitor anyway].

    What types of deals are you doing and what’s your minimum threshold?

    Ninety percent are tech deals right now. Another 10 percent are life sciences. We’ve done deals right out of Y Combinator on the low end; many of the deals we’re doing are with seed syndicates. We’ve also done deals north of $30 million, with several greater than $10 million in size this year, including Jet.com [the new e-commerce company by Quidsi cofounder Marc Lore].

    The seed stuff is interesting. You were actually involved with Facebook, as reported in David Kirkpatrick’s book, The Facebook Effect.

    We were the first venture debt for both Google and Facebook. We supplied debt along with Google’s Series A. With Facebook, we supplied two consecutive venture debt rounds of $300,000; they were buying servers because the cloud didn’t exist yet. We were also a seed equity investor in Facebook, writing a $25,000 check alongside Peter Thiel’s $500,000 check and the $37,000 checks of [entrepreneurs] Reid Hoffman and Mark Pincus, and we did a $3 million venture debt deal when Accel [led Facebook’s] $12 million Series A round [to cover the cost of computers and other hard assets]. The debt, in addition to the equity the company raised early on, helped position it for that next round. They don’t all go that way, though. [Laughs.]

    What kinds of convenants do you ask for?

    We have none . . . so we’re taking true risk. Our industry is known for taking money back when it gets nervous. Our firm actually loses money. It’s easy to lend money to a famous company, but much harder to work through unforeseen difficulties to keep a company alive and we’ll work through that adversity.

    What kind of return are you looking for when you get involved with a company?

    We have to deliver reasonably consistent, positive returns, but I’d rather not quote a number. There are often competitors that offer money less expensively, but it will come with covenants. Ours is more expensive but more usable. It’s a bit of you-get-what-you-pay-for in this industry.

    There are obvious upsides to venture debt, including that it reduces dilution to the founder. What are the biggest downsides?

    If it’s overused or abused, it can kill you. In any application of debt, there’s an amount that’s too much and it can get in the way. Say you’re a Y Combinator company and you raise $10 million in debt; the next round of investors won’t be interested in coming in with that kind of debt load. No one wants to finance a company that’s overburdened with debt.

    If debt can be called back, it can cause unforeseen calamity, too. If your bank account has been swept, legally, that’s scary for companies.

    You haven’t seen any reaction outside of the media to Bill Gurley’s proclamations last week. Does that worry you?

    We ourselves feel as if things can’t get a whole lot better than the current environment. A lot depends on Facebook and Google. If they trade down 20 percent, you can be sure the venture market will take a pause. It’s imperative that they keep feeding the pump from the M&A side.

    Any thoughts on valuations?

    Most valuations that you’re seeing are by no means the value of company if it were to try to sell itself today. It’s the Black-Scholes model – [pricing options] based on what a company might become worth, which could be very different than what it’s worth [currently]. That, I think, is dangerous.

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