In a sign of the maturation of L.A.’s tech industry, venture debt financier Hercules Technology Growth Capital Inc. is opening an office in Santa Monica.
Hercules, based in Palo Alto, invested $1 billion in venture debt deals last year. It said the growing number of late-stage tech companies in Southern California makes the region ripe for more debt financing. The region attracted $4 billion in venture capital last year – a record – and that implies Hercules will have more companies to invest in later.
“Statistically, the L.A. ecosystem has recently been the No. 3 region for venture capital investment,” said Managing Director Tim Barnes, who will be leading Hercules’ one-man Southern California office. “There’s a lot of exciting tech companies in the market. For Hercules, the feeling is, it is an opportunity to pursue growth.”
Hercules expects the Southern California venture debt market to be about $1.6 billion in 2015, he said. The investment firm will be targeting technology, life sciences, health care and energy technologies. Average debt financings from Hercules are about $15 million, though the amount can vary from $5 million to $100 million. Loan duration is typically 36 months to 42 months, the company said.
Venture debt is used as a less expensive way for typically late-stage companies to finance their growth without selling more equity. Loans usually include warrants to buy stock, so that lenders can participate in the upside of any company IPO or buyout. It is often done alongside of equity sales or in lieu of equity sales, as a form of bridge capital.
“It’s designed to extend company runway to a milestone event like an equity round IPO, an M&A event or profitability,” said Senior Director of Investor Relations and Corporate Communications Michael Hara. Debt financing comes at “a time when the entrepreneur does not want to give away equity because he knows it’s dollars out of his pocket.”
Hercules will have some competition for the Southern California venture debt market though. There are already several banks doing venture debt deals in Southern California, including City National of Beverly Hills, PacWest Bancorp of Century City, which is buying Square 1 Financial Inc., and Silicon Valley Bank of Santa Clara, which over the last nine months has doubled its staff focused on venture debt to eight employees.
“There are a number of banks headquartered here. It’s made it incredibly competitive, easily as competitive as or more competitive than Northern California,” said Silicon Valley Bank L.A. Market Manager Rob Freelen. Yet, “most banks in the country don’t deal in venture debt deals that are larger than $10 million.”
That has created an opportunity for non-bank lenders like Hercules, whose higher cost of capital compels them to invest in larger deals, he said. With more and more late-stage tech companies such as Snapchat, Honest Co. and Dollar Shave Club in Southern California there should be plenty of opportunity for large venture debt financing, he said.
Moreover, beyond L.A.’s growing number of late-stage companies, Hercules is setting itself down the pipeline from an even larger swell of young, seed stage companies in Southern California.
“We like to watch the early stage companies because some day they’re going to be potential clients,” said Hara.
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