Maurice Werdegar is the longtime CEO of venture debt shop Western Technology Investment, one of the most active venture debt lenders in the U.S.
It’s also one of the older firms, having loaned out money for roughly 40 years to startups that needed to achieve certain milestones, reach profitability or wanted additional runway and didn’t necessarily want to raise a new round (especially if that next round might be at a lower valuation).
It’s a needed service and a boon for startups in good times. But when the market turns, debt can prove much trickier.
Indeed, though Werdergar understands founders well — he was once the CEO of a venture-backed restaurant chain that did really well until it didn’t — he also has to make certain that when the market shifts, things don’t go south for WTI, as well. That can mean long, hard conversations with founders who need to renegotiate their debt payments.
Because COVID-19 is wreaking widespread economic havoc, we talked with Werdegar last week to learn what’s happening in his world and what WTI can do for clients who are now in a bind. Our chat has been edited for length.
TechCrunch: There are other venture debt players out there. How do you differ from your competitors?
Maurice Werdegar: One is we’re not publicly traded; we’re a private BDC [business development company], so we get our money from institutional investors, university endowments, nonprofits, sovereign wealth funds and groups like that. We’re a team that’s comprised primarily of former entrepreneurs; all of us have started and run our own businesses and work closely in the entrepreneurial environments. And we don’t use financial covenants, nor do we use subjective defaults.
What’s a subjective covenant?
In some lenders’ documents, a lender can say that there’s been a material adverse event, perhaps a macro event in the world such as we’re going through today [and] a lender can call their money back… Again, we don’t have those at WTI.
Do you have some type of covenant around how much money a company keeps on its balance sheet, or are there no financial covenants whatsoever?
There are no financial covenants whatsoever. We do not require a certain minimum amount of cash to be on a company’s balance sheet.
We talked last week with Alexis Ohanian and Garry Tan of Initialized Capital about the debt market, and they mentioned that it’s a great time for debt lenders to be lending money, given that short-term interest rates are now zero or practically zero. How does that factor into your calculations?
Our market is really not correlated to what’s going on with the Fed borrowing rate. We’ve seen pricing modestly move higher, and that’s because of the demand for capital in this environment. It’s an alternative to venture capital. So I wouldn’t say that we’re correlated to movements in the interest rate environment.
And I guess I’m not sure I agree with what Initialized said about it being a great time to be a lender. Many of the people that we know in our marketplace are not looking to deploy new capital right now. They’re very focused inwardly, and I think there’s a very different risk tolerance than there was just a short time ago. I would say the typical venture-backed company is going to have a harder time raising venture debt today than they have previously.
In dicey times, lenders tend to pull in their horns. And all of us, I think, are trying to be thoughtful about what we’re doing with new capital that we’re deploying.
What kind of conversations are you having with your portfolio companies today about the way forward in this crazy climate?
We’ve just done a check-in with all of our companies to understand how they’re doing. We rated the whole portfolio from everywhere from an A — which would be a company that was already doing well and might even have a better opportunity now due to some business process changes — down to an F, where a company was underperforming and was hoping to raise money or have an acquisition in the near term, and that’s going to be challenged.
If we’re being asked to restructure alone, what do we do? We look at it as a three-legged stool where we collaborate with the company to try to understand their go-forward plan. Most companies are re-forecasting and cutting expenses. In many cases, management is cutting their salaries all the way to minimum wage just to make sure the cash can last longer.
Then of course, there’s the question of whether or not inside investors want to put in more capital. For us, there is a three-legged stool. It can stand on its own if WTI comes together with management and new capital from investors to give companies 12 to 18 months of runway. So those are the types of things we’re asking: Does this plan make sense? Is there participation all the way around the table? And is there a winning strategy that we can all look forward to?
What about new deals?
On new deals, we’re asking similar questions, but it’s about in the current environment, as best as we can see it, what does this business mean? And how much runway do they have? And why will they continue to be able to execute and prosper amid what are just very different headwinds than we’ve seen before?
And many companies have a good answer to that. Certainly companies in telemedicine and medical diagnostics and virtual meetings and next-gen insurance companies with niche products are benefiting from this environment. But then there are sectors that are really having a difficult time, [like] online recruiting, some of the real estate tech, certainly some of the bricks-and-mortar retail.
I think one of the biggest risk factors we know a company might have is the valuation being very high and therefore a disincentive for new investors to want to put in money. It’s very difficult to do an inside round or a down round with a company that’s overvalued. And so that’s something we also take into account.
Do you ever make your continued participation in a deal contingent on additional warrants or perhaps a board seat?
We don’t take board seats because we believe that there is a divide between debt and equity, and that it’s the responsibility of the equity investors to be on the board and for the debt player to have a different role. There is some inherent conflict of interest if a debt provider is on the board of a company.
[And] we don’t typically look for additional compensation as we scale our investments. Instead, we often will structure investments with milestone-based fundings, where companies need to prove that they can execute it against a plan roughly, such that we’re funding increasing success metrics. So we’ll talk with a team about layering in our capital upon the achievement of inflection points and milestones that make it safer and safer for them to take on more and more debt.
It may be counterintuitive, but as these companies progress and hit these milestones, [debt] can be safer.
You say VC participation in these deals is pretty crucial to you. You also say you’re rating these deals on an A to F basis. What do you do with the companies that rate an F?
These might be companies that otherwise had very good prospects but had the misfortune of being in the middle of financing or M&A discussions and therefore very short on cash right now. In those cases, we may get through to the other side with them, but it’s going to take that three-way approach, with some additional capital, some significant belt-tightening and then some loan relief from us. So we are spending time trying to collaborate with the companies that are in the most dire trouble. But we don’t walk away from relationships.
As a fiduciary, even if a company ultimately does run out of cash and even if it has no forward prospects, we’ll then work with its management team to see if there’s a plan to sell the assets, or maybe to license the intellectual property, or maybe mothball the technology and seek further patents in the future, or maybe recap it and restart it. We’ll do almost anything we can that makes sense with a management team, and we’ll try to compensate them to help us be part of that strategy going forward [to] ultimately try and get our money back, even if it takes years and years.
Given these unprecedented times, are you offering loan relief to a number of your existing portfolio companies?
I think the ones that we would look at for restructures or loan relief would be ones where there’s a real significant hardship. Not all companies are going to qualify for that. So we’re going to spend our time and our effort and our restructure bucket on companies that need it most and where we can have the biggest impact. Again, it’s going to need to pass the test of there being a thoughtful plan with shared participation from management, from investors and from us toward the common goal of trying to extend the time frame for a company to reconfigure itself to survive.
Would you defer payments altogether for a certain period of time?
We can. That’s rare. I would say the more typical response would be a reduction in payments of some amount from whatever it was previously agreed upon. But if a company can’t pay, then it can’t pay. So in those instances, it could mean a total deferment of capital. And we would consider that if there was a reason, [as when] that capital was going toward trying to complete an M&A transaction, for example. But that would have to be a company that’s very short on cash — probably less than 45 days’ worth of cash — with no prospects for further participation from inside investors to put in more money.
It might be a company where they’ve already done two inside rounds and failed to meet some key objectives that were set out as the goals of that plan. So they might really be up against it.
Fortunately, we don’t have many of those, but in the instances where we do and management’s working for minimum wage toward the goal of trying to bail us out and has the right positive attitude, we’ll do that. The last thing we want is having management walking away from the company, because they’re our only hope.
