Christopher J. Woolley, senior vice president and regional manager for Imperial Bank’s Pacific Southwest emerging growth division, exemplifies the changing face of the Los Angeles banking community.
Time was, commercial banks took deposits and extended mortgage or business loans secured by assets, accounts receivable, or something else a banker could see, touch or feel. Taking risks with federally insured deposits was a practice frowned upon ever since the Great Depression.
Now the youthful Woolley he’s 41 has a lot of Imperial Bank loans riding on “growth companies,” and many of them have been financed by venture funds. Moreover, Imperial Bank invests in venture funds, including Santa Monica-based Digital Coast Ventures, downtown Los Angeles-based Zone Ventures and Innocal in Orange County. Through a bank arm a Small Business Investment Corp., or SBIC Imperial Bank has even done a little direct early-stage venture investing.
So far, Woolley is looking good. Not only is his emerging growth division the most profitable of Imperial Bank’s four major divisions, but by developing relationships with venture capitalists and growing companies, Woolley is garnering deposits and future business for Imperial Bank’s other divisions as well.
A former stockbroker and Big 5 CPA, Woolley says Wall Street doesn’t really understand the Imperial Bank story. “We have warrants on more than 500 growth companies” in California, said Woolley. “That isn’t reflected in our balance sheet. But the warrants are ours.”
In an interview last week, Woolley offered an assessment of banks’ growing appetite for venture-related business deals.
Question: The emerging growth division is Imperial Bank’s most profitable. But obviously, growth companies are inherently unstable witness the “tech wreck” in April. How do you make money, as a lender?
Answer: The profitability has been driven by warrants. Generally speaking, warrants (the right to buy stock in the future, at a fixed price) on the company’s stock are a condition of getting a loan from the emerging growth division. If you don’t need to give up warrants, then you are probably a candidate for one of the bank’s other divisions.
Q: What type of warrant structure are you looking for?
A: We look for warrants in the 5 percent to 10 percent range. If we extend a loan for $1 million, then we want to see $50,000 to $100,000 in warrants.
Q: You still charge interest on the loan, right?
A: Oh, yes. A typical loan would be the prime rate plus 1 or 2 (percentage points), plus the 10 percent in warrants, plus a 1 percent fee. The loan is basically the same as an Old Economy loan, if you will, but with warrants attached. On the loan itself, we only take the most senior secured lending position.
Q: What size loans do you extend?
A: Anywhere from $500,000 to $15 million, and our average is $1 million. Almost all of our loans are between $500,000 and $5 million. We have about $500 million in loans outstanding, in the emerging growth division.
Q: That sounds pretty lucrative you have a loan portfolio that earns interest at above prime rate, is secured, plus you get warrants on top of it?
A: Yes.
Q: But what is the price on the warrants?
A: We generally take warrants equal in price to the latest round of investors. Often we lend concurrent to, or shortly after, the latest round of equity investing. So whatever price the investors take, we take too. We are usually looking to lend to companies that have been backed by first-tier venture funds or investors.
Q: What is the time horizon on the warrants?
A: A five-year warrant would be very typical.
Q: Obviously, your “liquidity event” is earlier, if a company goes public, or is merged?
A: Yes, but remember, we are often locked up after an initial public offering, usually for 180 days. The stock can skyrocket, but we are sitting there watching, and it can come back down, and we can’t sell. But after a merger, we can sell right away.
Q: In how many companies do you have warrants?
A: We are over 500, getting close to 550.
Q: How do you keep track of all of that?
A: We have a group within the bank that manages our pool of equity. It is headed up by Jim Rutter, who actually works on Sand Hill Road in Palo Alto. It is part of the emerging growth division.
Q: Still, that’s a huge portfolio, with about 20 times as many positions as even large venture funds. It must be a tough oversight job…
A: We lend, and take warrants, but only when we see first-rate institutional venture capital money gong into the deal. They have vetted the management, they (the venture capitalists) have the experience, they do the due diligence although we do our own, too they have their own money on the line. You have smart VCs who have spent a long time looking at this, and then we follow on, or piggy back on them. But they have risk capital in line behind us, if things go wrong.
Q: How many warrants are in the money?
A: Of the 549 positions, 66 are now in public companies. They are worth about $29.8 million, in unrealized gains.
Q: If my math is correct, that works out to about $451,500 per loan, and your average loan size is $1 million.
A: Your calculator is as good as mine.
Q: Do the warrants figure in your personal compensation?
A: Yes. Although the warrants are kept within the bank’s name, within the emerging growth division, those people who are most closely associated with a loan get credited with the warrants extended. The more you had to do with the loan, the more work you did on it, the more warrants you get. There are some exceptions for example, the emerging growth division has an internal administrator, who doesn’t get involved in making loans, but he still gets a cut of the warrants. As a result of the warrants, we are the best-paid bankers within the bank, and probably within the industry.
Q: In addition to taking warrants in growth companies, do you also invest in venture funds?
A: Yes, we do. We do that, not only as an investment, but also to develop relations. We often become the banker to the fund, and to client companies, and their officers. It is as much a strategic investment as a financial investment.
Q: And you run a Small Business Investment Corp., or SBIC, which can make direct equity investment in companies?
A: It’s run out of the H.Q. in Inglewood, where the corporate headquarters of the bank are.
Q: Your former sister company, Imperial Credit Industries Inc., owns an investment banking arm, Imperial Capital, the old Dabney Resnick shop in Beverly Hills. Do you ever shuffle clients to them, or vice versa?
A: You are right, Imperial Bank no longer owns any part of Imperial Credit, which owns Imperial Capital. We haven’t done any business with that entity.
Q: Of course, Glass-Steagall, the old federal law that separated commercial banking from investment banking and securities brokerage, and both of those activities from insurance, was killed last year by the U.S. Congress. But still, the old fear behind that law remains. Are you going to start extending commercial loans to clients, because you own equity in them? To try to rescue a company, if you will, to make your equity whole? Are there conflicts?
A: Like most banks, we have an independent credit approval department, with their own guidelines, separate from the emerging growth division. I can’t extend any loan I need to get a colleague in the credit administration group to give a green light. There is also an internal audit group, and they are incented to keep the bank looking healthy. We are also audited by KMPG Peat Marwick and the FDIC.
Also, remember, the warrants take three, or four, or five years to mature. If you back a crummy company, it’s not going to make it. If the company is not good, the public market won’t ascribe any value to the warrants. This is not the instant-gratification business. We only want to back strong companies. If anything, we have less conflicts than at regular commercial banks, where loan officers get bonuses on loan volume generated. They have an incentive to make loans, not deny them.
Q: With Glass-Steagall gone, will you go into investment banking?
A: No plans now. We are a specialty business bank. That is our niche. I wouldn’t rule it out forever, but I don’t hear anybody talking about it. If we did do it, we would probably hire a few very top investment bankers and grow it slowly.
Q: What about insurance? You can sell insurance now, with the changes in Glass-Steagall.
A: Again, we have no plans to do that. We are trying to stay focused on our niche.
Q: Your division is growing rapidly, is it not?
A: Yes, we started eight years ago, first with one office in the Silicon Valley, and now we have 14 offices. We have offices in the VC capitals, such as Boston, New York, Atlanta, Dallas, Phoenix, Raleigh-Durham, and other cities.
Q: We hear a lot of hoopla that Los Angeles is a venture capital town. Is it true?
A: Yes it is. The combined San Diego, Orange County, Los Angeles market is either the second- or third-busiest market, after the Silicon Valley and Boston. The number of funds that have opened up here lately is remarkable.
Q: What is the future of a regional, aggressive bank like Imperial Bank, in this era of deregulated markets?
A: Well, I think we continue to expand the emerging growth division. We essentially track the VC dollars invested, and that segment has been growing, as you know. We think there is just a huge upside to this market. We have added a unit named “VC Services” that is specially designed to act as a banker for VC funds, so we think that will be another catalyst for growth. But we are not trying to be the biggest bank. We have pursued a course of being a specialty business bank. That is what we do.
