Tiffany Charles, CFO of Medtech Solutions, was facing a difficult challenge. Medtech, a venture-backed startup in business for two years, needed test equipment critical to its operations. While test equipment is widely available for most test applications, the tests to be conducted at Medtech required custom-made equipment offered by only one US manufacturer. Medtech had raised sufficient venture capital to fund most of its research and development projects, but the custom-made equipment’s cost would require an unacceptably large percentage of Medtech’s research budget, limiting investments in other key areas. Tiffany explored manufacturer financing and contacted several leasing firms, but to no avail. How would Tiffany acquire the equipment that Medtech needed without using internal funds critical for other projects?
Why custom-equipment financing is so difficult to obtain
Potential financing sources approach requests for this type financing cautiously. Most financing for venture-backed startups involves a high degree of risk in comparison to financing established companies. Financing sources that extend credit to venture-backed startups are accustomed to accepting startup risks. These risks include financing companies that are relatively new to their markets, that have negative cash flow, and that rely on venture capital sponsorship to stay afloat. Notwithstanding these risks, most financing sources are reluctant to take on the added risk of financing equipment that they may be required to re-market one day, but are unable to move. Many of them know that a small percentage of the transactions they underwrite will not work out, requiring them to repossess and re-marketing the equipment to recover as much of their investment as possible. Custom-equipment presents a huge challenge in that it offers virtually no backstop should all other exit channels fail.
Whether or not a venture-backed startup can obtain financing for custom-equipment might depend on several factors:
- The dollar amount and percentage that the equipment represents of the total to be financed
- Whether other assets can be offered as collateral to secure the transaction
- The startup’s overall credit profile
- Whether management can convince the financing company that the equipment is critical to operations and/or profitability
- Whether an aftermarket exists and whether there is any prospect of realizing value from the equipment if re-marketing is necessary
- Whether the vendor offers equipment buy-back, trade-in, or re-marketing support, if desired.
How do savvy startups overcome this financing challenge?
To improve the odds of obtaining financing, startups should take the following steps:
- Stick with financing firms that specialize in financing venture-backed startups. These companies understand venture risks and are in a better position to evaluate transactions involving custom-equipment.
- Research the after-market for the equipment by talking to the vendor and looking for used equipment brokers/dealers online. Often, the vendor can provide resale information and used equipment resellers can be spotted online via advertisements and postings. Make sure you provide your re-marketing research to the financing firm.
- Explore re-marketing assistance with the vendor, including equipment buy-backs, trade-ins, or other vendor re-marketing arrangements. Depending on the vendor, customers may be able to lobby for special re-marketing arrangements as a purchase incentive.
- Consider other assets that the startup might pledge to support the transaction. The main concern of the financing source is being able to exit the transaction should the startup default in making payments. By offering additional collateral to support the transaction, the startup may be able to alleviate or greatly reduce this concern.
- Try to schedule custom-equipment purchases along with other equipment that has an established aftermarket, such that the custom-equipment represents a minority of the equipment being acquired. Similar to offering additional equipment as collateral, by bundling custom-equipment with readily re-marketable equipment, the overall collateral value of the bundle might be sufficient to calm the financing provider’s concerns.
- Highlight the critical nature of the equipment. If it is critical to the startup’s profitability or operations and loss of the equipment’s use would put the startup in a significantly weaker position, the prospect of obtaining financing is somewhat improved. The rationale is that the financing source will have a relative advantage vis-à-vis other creditors in any company wind-down because the equipment might be needed to restructure the company or to assist other creditors in their recovery. While this is not a primary reason for financing custom-made equipment, it is a factor considered by most financing sources in making a final decision.
If your startup needs financing for custom-made equipment, use these tips and insights to navigate your search.