Loyal readers know that Elevator Pitch features a different venture capitalist every week. But our latest guest is an ex-VC — though he still invests in venture-backed companies.
Manuel Henriquez spent years in corporate venture (as president of Comdisco Ventures) and traditional Sand Hill Road VC (at VantagePoint Capital Partners) before striking off to do a different kind of tech investing. “Venture debt” isn’t a very sexy term, but it’s one that can give entrepreneurs an additional way to raise money without having to give up ownership in their companies.
We asked Henriquez, the CEO and co-founder of Palo Alto’s Hercules Technology Growth Capital, why venture debt is an increasingly popular tool.
Q: HOW’D YOU GET INTO THIS RACKET?
A: I’ve been involved with emerging companies since 1983, when I started my first company while still in college. Ten years ago, I started Hercules with two co-founders and a simple charter: To help entrepreneurs gain access to growth capital that is complementary to, but less expensive than, traditional venture equity so they can build out their business models and realize their dreams.
This complementary capital opens up possibilities for emerging companies that generally would not qualify for traditional loans because of a lack of revenues or cash on hand. And it helps founders avoid the dilution that would result from having to raise additional VC money before they are ready. This additional layer of capital essentially extends the “runway” of the VC dollars that have already been invested. Clearly there was, and continues to be, a need for this type of growth capital, and after 10 years we’ve done almost $4 billion worth of transactions in over 250 companies.
Q: WHAT DO YOU LIKE ABOUT STARTUP INVESTING?
A: First of all, I am a serial entrepreneur myself, having started five or so companies — some of which failed to scale, and others of which I chose to sell, including a dot-com pet play called HealthyPets which was sold to Petopia.com. I will always have a special place in my heart, not to mention respect, for others who go out and try to build something.
Second, even though Hercules has become a billion-dollar, publicly traded company, I try to run it with the same entrepreneurial culture we had when we started, so that we are able to always remain nimble and easily adapt to change. Finally, by financing startup ventures, we are able to work with cutting-edge, disruptive companies which, like us, are dedicated to changing the way things are done. Being able to help facilitate this process is very exciting.
Q: WHAT KINDS OF DEALS ARE YOU LOOKING FOR NOW?
A: At Hercules, we focus on four main areas: Technology, energy technology (aka cleantech), life science and an emerging sector called special situations. And we only invest in approximately 15 to 20 percent of the deals that come to us.
Currently, we are heavily weighted to life science companies, although our portfolio continuously shifts between sectors and stages of company development depending on market conditions. Life sciences has seen robust IPO and M&A activity, even though the headlines are dominated by a handful of high-profile technology IPOs. At the end of the day, what we are looking for, regardless of sector, are companies that have great people, are well backed, and possess what we think is a sustainable business model and an innovative and defensible approach to the market they are serving.
Q: WHAT’S THE BIGGEST MISTAKE ENTREPRENEURS MAKE?
A: Entrepreneurs by nature are strong-willed people and, to be fair, I put myself into this category. While having a vision is critical to success, there is a tendency for some entrepreneurs to believe that there is only one way to do things, and that’s a big mistake.
As an entrepreneur, I have come to learn that being able to take constructive criticism from your team as you navigate the many forks in the road is absolutely essential, since making the wrong decision at any point along the way can be catastrophic. Those entrepreneurs who are able to maintain this balance dramatically increase their chances of building a successful company.
Q: WHAT’S THE NEXT BIG THING GOING TO BE?
A: We think there are tremendous opportunities in the energy technology area, or what used to be called “cleantech.” Many people only think of solar or wind when envisioning companies in this sector, but we take a much broader view. Attitudes about the environment, geo-political energy dependency and changing demographics make this a very interesting place to be, and I think we are only in the second inning of a very long game.
For example, while fracking is viewed negatively by many, it is likely here to stay, and there are companies out there looking for ways to make it more environmentally friendly — especially by treating the water that is contaminated during the fracking process. If these companies can successfully make this water safe to be re-released into the environment or reused, that’s a home run.
Q: WHY’D YOU MAKE THE SWITCH FROM VENTURE CAPITAL TO VENTURE DEBT?
A: I spent almost two decades making equity investments into companies with firms such as BancBoston Ventures, CrossLink Capital (aka Omega Ventures) and VantagePoint. During this time, I saw a shift in the fund-raising channels traditionally tapped by the venture capital community, and I thought that the public markets could be an interesting alternative. This turned out to be the right decision, as evidenced by others who have since pursued a similar strategy, and has allowed us to reach the scale we’ve achieved today.
I also wanted to create an entity that gave the average investor access to an asset class that very few people can enter. Remember, not everyone has the liquidity necessary to invest in a VC fund. We give investors a portfolio of over 110 companies to which we have warrants or equity investments. It’s a broadly diversified, ETF-like portfolio of pre-IPO companies at different stages of development that represent a range of industries and geographies and are backed by a wide variety of leading venture capital firms.
A: I have seen a lot of cycles in my career — from the original banking bubble of the late 1980’s, to the dot-com crash to the most recent credit crisis — and I do not believe that we are currently in that sort of bubble, at least not yet. However, do I believe, and see evidence, that certain sectors are exhibiting “bubble-like” characteristics.
That’s okay, if limited to a few companies within a sector. Just because there have been a few recent IPOs with high valuations does not in and of itself mean that we are seeing a repeat of 1998 and 1999. The volume of IPO companies realizing liquidity today pales in comparison to that period of time.
Having said that, there is always a tendency for valuations to become frothy as the IPO market opens and optimism takes hold. I cannot speak for other investors, but the key for us has always been to maintain our investment discipline and continue to perform the due diligence necessary on a company-by-company basis. If we continue to do this, we expect our portfolio to perform quite well, regardless of whether or not we enter a bubble.
Regarding companies like Twitter and Snapchat, it remains to be seen if the valuations they have achieved are warranted, given their growth and disruptive business models. However, these companies, and the businesses they have built, are light years ahead of the types of companies that came to market the last time around. The days when any dot-com could slap together a website and pray that users would follow are long gone. Business models are much more fine-tuned, the VCs demand more accountability, and the equity capital markets are far more discriminating — hence the trickle of IPOs today compared to 1998-2000.