Gearing Up

A start-up saves money and time by obtaining equipment through a venture leasing deal.

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Venture leasing can give new companies a head start on equipment

Ed Bartlett brought his Harvard Business School training to his new job as president of a start-up company. And he brought eight years of experience with big-company finance. But he didn't bring any illusions. He knew the long list of financing options available to an established company would be quite a bit shorter at Nationwide Remittance Centers Inc. (NRC). He just didn't realize what living with a short list would be like. Talking to one financier, he remembers, "was like dealing with a hit man at the end of the dock."

Few start-ups will escape the "give-up-an-arm-and-a-leg" school of finance. They're just too risky. But lately some have been discovering that the list of alternatives is growing. Bartlett, a 42-year-old convert to small-company life, is using a new, little-known financing technique called venture leasing. Venture lessors rent equipment to brand-new companies in return for a pricey rental rate and a slice of the company's equity.

While those aren't exactly bargain-basement terms, they're better than no terms at all. Banks and traditional leasing companies won't deal with start-ups. Or they require such customers to put down a large cash deposit -- 30% to 70% of the price of the equipment. That, of course, raises the cost of leasing enormously. More important, it ties up capital that is almost always desperately needed someplace else in the business.

In contrast, venture lessors' charges are relatively painless: a buried interest rate at least two percentage points higher than an established, creditworthy company would pay and an equity stake that is usually less than 2% of the company.

There is a catch, though. Most venture lessors will lease only to companies that have already been financed by venture capitalists. That way, they figure, they're more likely to get a customer that is well funded and well managed. But some will make exceptions, and their number may increase as the industry grows.

Back in early 1987, when Bartlett was looking for lease financing, NRC had two venture backers and a business plan, but not much else. Getting some kind of leasing arrangement was critical. First, Bartlett wanted to hold onto the precious $2 million of venture capital cash he had raised. At a total cost of about $500,000, the equipment he needed would chew up a quarter of it.

Second, NRC's entire operation depended in large part on its equipment -- 25 Data General minicomputers. NRC's business is to collect money for companies faster than they can collect it themselves. For example, to help an insurance company gather the premium payments that its customers send in from all over the country, NRC accelerates two processes: the time that a check spends traveling through the mail and the time it takes to clear through the banking system. The minicomputers, to be installed in 25 banks around the country, were essential to the second part of NRC's service. And, of course, the equipment had to be in place before NRC could begin to take on customers.

Initially, Bartlett tried to get Data General to finance the computers. After all, who would be better motivated to make a deal? But no dice. To do its analysis, DG used a Citibank program that evaluates potential lessors on their cash flow. NRC, of course, had none.

Next stop, venture lessors. Of the handful of companies doing venture leasing at the time, Bartlett liked San Francisco-based Dominion Ventures Inc. best. Geoffrey Woolley, managing general partner at Dominion, describes himself as 80% venture capitalist. "You don't take the risk on the leasing side of the business. You take the exact same approach that a venture capitalist does," he says.

Not that the equipment in question doesn't matter. Dominion didn't turn cartwheels over NRC's choice of Data General computers, for example. "Although DG is known as a good hardware company, its reputation is weak when it comes to software and service," Bartlett explains. DG computers are likely to be worth less at the end of NRC's lease. So Dominion forecast a lower "residual value" for the gear, which raised the cost of the lease financing.

NRC's total leasing costs were also higher than they had to be because, eager to get the business started, it had bought the computers before it struck a deal with Dominion. That meant it had to sell the computers to Dominion before it could lease them. This sale/lease-back feature required NRC to pay the sales tax on the computers twice -- a $25,000 expense -- and to take a $78,000 loss on the sale of the equipment to Dominion. It would have been cheaper and less of a paperwork nightmare to let Dominion buy the machines in the first place.

Here's how the deal worked: Dominion offered NRC a $750,000 lease line, which could be drawn on during a four-month period. After four months the $500,000 that NRC used turned into a loan, to be repaid over the course of three years.

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