New Firms Turn To Venture Banks

When the founders of young technology companies need to secure loans and set up lines of credit, they often can’t turn to
conventional banks, because those institutions rarely loan money to start-ups without revenue, profits or sizable assets.

By Nicholas Johnston, Washington Post

But they have an alternative: venture banks.

"We provide credit to early-stage companies based on the
quality of their investors," said April Young, a managing
director at Comerica Inc. who runs the bank’s mid-Atlantic
venture practice. "Typically, they’re not bankable by
conventional standards."

Comerica and another institution, Silicon Valley Bank, both
with offices in Reston, are the nation’s primary sources of
financial services for venture firms and credit for
venture-backed companies. They take deposits and make
loans for early-stage technology companies, clients that most
banks shy away from.

"They’re really the only players," said Rosalind Looby, a
senior analyst with Credit Suisse First Boston.

During the technology boom of the late 1990s, many banks
vied to grab a share of the business from cash-rich start-ups.
But after the stock bubble burst in 2000, venture banks
remained in the market while others dropped out. Despite a
big decline in deposits, from which these banks make most of their money, venture banks are still in the field.

"If the big banks really want to get into this business, they could," Looby said. "But it would be tough."

It would be difficult for larger banks to duplicate what venture banks do, say venture investors, executives, analysts and the
venture bankers themselves, because venture banks understand how technology start-up companies work, from the money they
raise to the industries where they operate to the profits they sometimes don’t have.

"They understand technology companies better than anyone else," said David Piper, chief financial officer at MainControl Inc.
in McLean. "That is an intangible factor that most businesses really can’t overlook."

After raising more than $20 million in venture backing about five years ago, MainControl began trying to put together a line of
credit to pay for the mundane expenses of running a business, such as equipment purchases and office leases, without having to
draw on its money from venture capitalists. (Venture capital money is expensive; companies have to give up equity to get it.
Taking out a loan may be more expensive in the short-term, but the company retains control of its shares.) But no local banks
would make a loan to the company, then a year old.

"At the time when I was looking, there were no traditional commercial banks that were willing to extend credit to us," said Piper.
"I remember talking to local banks in the area, and you couldn’t find any one of them that was really interested in lending to
technology companies."

MainControl, as a young start-up, didn’t meet the small-business criteria that most banks use to gauge possible loan candidates.

"The type of lending we’re doing doesn’t fit in the mold of traditional lenders, who are more focused on three years of
profitability, collateral and personal guarantees," said Mike Selfridge, senior relationship manager at Silicon Valley Bank.

Venture banks count on venture capitalists, who screen potential clients. Venture capital firms typically subject their investments
to rigorous scrutiny before committing any money. And venture firms also help drive new business to the bank.

"They have established relationships with a select number of venture funds," said Josh Fidler, a partner at venture firm Boulder
Ventures. "It’s very much symbiotic."

Novak Biddle Venture Partners, another venture firm, uses a venture bank for cash-management services and lines of credit for
companies it has recently funded — usually an amount equal to about 20 percent to 30 percent of the funding round’s size. Joy
Binford, Novak Biddle’s chief financial officer, said she can’t imagine finding a traditional bank familiar enough with venture
investing and start-up operations to be effective.

"It was a no-brainer at the time to use a venture bank," she said. "They understand the venture capital side, and they understand
what we need for our start-ups."

To some degree, venture banks operate much like other banks. They take deposits from their customers — both start-ups and
venture capital firms — and have a traditional set of financial services for their commercial clients. But the focus on young
technology companies does result in some stark differences.

For instance, due to the risk involved in lending to young technology companies, venture banks charge higher interest rates —
usually one or two points above the prime rate. But unlike traditional banks, venture banks make their money on deposits. A
start-up that has just raised $10 million from venture capitalists might eventually need a line of credit, but it immediately needs
somewhere to stash its cash.

"If you’re a venture-backed company, you don’t need a whole lot of debt financing," Looby said. "What you’re really in it for is
the deposits. Those are usually cash-rich companies."

A reliance on venture-backed deposits has hurt the banks in recent years as the levels of venture investment have plummeted.

At Silicon Valley Bank, deposits fell 30 percent, to $3.4 billion, in the year ended Dec. 31. In the same period at Riggs National
Corp., a local bank of about the same size, deposits grew 11 percent, to $4.5 billion, according to the Federal Deposit Insurance
Corp. Comerica said it doesn’t separate its venture-banking business from the rest of its commercial operations, but the entire
California-chartered bank had deposits of $13.3 billion, up sharply from the year before, primarily due to acquisitions.

Silicon Valley Bank is the older of the two venture banks. It was founded in Santa Clara, Calif., by a group of commercial
lenders and investors in 1983.

Comerica’s venture practice was founded in the early 1990s by a group that had left Silicon Valley Bank. They joined Imperial
Bank, a 25-year-old commercial bank in California, and formed a venture-banking practice. Comerica bought Imperial last year.

Silicon Valley Bank’s exclusive focus on the technology industry has caused some problems in recent years as its loan portfolio
collapsed. According to Looby, the bank’s return on equity — one measure of a bank’s performance — dropped from 25 percent to
just 9 percent. The industry averages around 15 percent. Imperial Bank also went through rough times before it was bought by
Comerica. However, Looby added, the worst of the problems with both banks’ technology portfolios are mostly behind them.

And now both banks face the constant threat that they could lose a surviving customer to a larger bank.

But Elizabeth Hess, vice president of finance at Megisto Systems Inc., downplays that possibility. She was the fifth person hired
at the telecom start-up, and as the industry weathered repeated storms, the firm’s venture bank stuck with them. As Megisto
grows, Hess said, it doesn’t plan to look at other commercial banks.

"You place some value on having a strong banking relationship," she said. "You need to know your bank will back you."

Reported by Washingtonpost.com, http://www.washingtonpost.com

© 2002 The Washington Post Company

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