Tech funding: ‘Debt is a great option’ for growing firms

For many growing tech firms, the route to finance largely involves trading equity in the venture capital arena. Much is made of any venture capital funding, worn as a badge of honour. However, regular business lending is making a comeback.

Debt financing may come across as a little staid compared with the glamour of securing money through equity. However,a number of well-known Irish tech firms have gone down the debt-financing route of late. These include Version One, Netwatch and hotel-booking platform Roomex, which recently secured €1.5 million of debt finance to help fund its ongoing investment in research and development (R&D). Elsewhere the debt-financing option is also being used by the likes of Netflix, which last year announced plans to raise just over $1 billion in foreign debt financing to fund new content.

Adrian Mullett, a former senior market analyst with the biometrics software firm Daon, is now head of technology sector at Bank of Ireland. He says that while debt is nowhere near as sexy as venture capital, that doesn't mean it isn't a sensible route for firms.

“I think the Irish technology sector has a number of companies that are well established, are throwing off some revenue and have costs that are dropping and which are a good fit for debt,” he says.

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“If you can do debt as a tech company, it is a great option. You get to control ownership, build a good relationship with your lender, the monitoring isn’t particularly intrusive and no one is looking to get a seat on the board,” he adds.

Mullet says but there are advantages to opting for the debt route for both tech firms and banks.

“The question for a bank is whether we can get in or out so we’re not taking an equity stake and are going in at a relatively low percentage. This means that if a customer can get senior debt from us they are getting it at a range of maybe 5-6 per cent lower than venture debt, which is pretty significant,” he said.

Understandable scepticism

As someone who is working for a bank, you might expect Mullet to be pro-debt. But he admits that with Irish banks, including Bank of Ireland, having bided their time before fully embracing the tech sector, there are many that are wary of them as lenders.

“I think there is an understandable scepticism about the banks and how open they are to lending and the reality is banks weren’t historically equipped to analyse tech companies. But we’ve been firmly focusing on this sector for four years now and have gotten to know it well. We have a good offering and are seeing significant growth on the back of a lot of referral work,” he says.

“The technology sector is never going to be the mainstay of Bank of Ireland but we’ve gone from a situation where we felt it was something we should be involved in more fully to a situation where there is now a very strong commercial rationale for being in this space,” he adds.

Bank of Ireland recorded more than 30 debt-financing transactions from technology companies in 2017, with the value of such transactions up 50 per cent compared with 2016.

Mullet says that in terms of customers the bank is pretty much sector agnostic but there are some strict criteria that companies must meet.

“Our clients would be strong, well-established technology businesses with nice contracts that are looking at the next step,” he says, adding that there are instances when the company will also consider supporting early stage and/or loss-making firms, depending on their particular circumstances.

Moreover, given that the banks expect regular repayments, debt financing isn’t something that companies investing in research and development usually opt for.

“We have funded R&D projects but that’s typically much more of an equity play rather than a debt one,” says Mullett.

Accurate figures

Another core difference with equity investment is that, rather than seeking to inflate the figures, debt financing is all about having accurate ones.

“The key advice is to be very careful around the projections you give because you can be haunted by them. We take projections seriously, which can be a big issue for some companies because they put in unbelievable figures. The thing is they don’t need to do this because the key thing we’re looking at is whether they can service the facility, so they risk damaging their credibility when they inflate the figures,” says Mullet.

“We also always guide companies to avoid evangelical forecasting. The scenario that a debt provider looks at is very different from an equity provider, so you might well be worth €200 million in five years’ time but we’re probably looking just at the next three years. In addition, we tend to do a much deeper dive into a company’s financial model than they might be used to in terms of cashflow and so on. We also look more closely at the assumptions to consider what might happen if things don’t go well and how easy it would be to strip out discretionary costs etc,” he adds.

Given the strict judging criteria, not everyone gets a pass. However, Mullett stresses that getting turned down needn’t mean companies should not consider debt financing at another time.

“Most of the cases we haven’t done of late would be reliable debt opportunities in the next 12-24 months. They are solid companies but just didn’t demonstrate the financial profile for debt.”

There is a strong functioning debt market for technology companies in Ireland and we’re playing a key part in that,” he concludes.