Friday Edition: Venture BDC's

Last week we took a look at some Business Development Companies with close ties to private equity firms. These firms are financing takeovers, expansions, and add-on acquisitions side by side with some of the greatest private equity investors on the planet.

The Business Development Companies are lending money to technology companies before they go public. Often, they will get warrants and options part of the loan package to participate in the success of the companies in their portfolio and collect interest on the loans.

They are part tech lender and part venture capital in many respects. These BDC's offer investors who need income to participate in the massive potential of things like artificial intelligence, driverless cars, cybersecurity, digitally enhanced supply chains, blockchain, software as a service, and all the other breakthroughs that print billions of dollars for Venture capital investors.

What they don't tell you about venture capital is that 75% of all startups fail and more than a third of these failures are a total loss for investors. Your odds as a venture investor of hitting a home run are minuscule at best.

Your odds of consistently making money by lending to potential unicorn companies and taking some equity exposure as part of the package is a much more consistent way of being a conservative, aggressive investor in venture capital situations.

Hercules Capital (HTCG)is a business development company that focuses on life sciences, software as a service, renewable and sustainable technology, and a catch-all bucket they call special situations. With a market capitalization of $1.82 billion, they are the largest BDC catering to high-growth venture capital-backed companies.

Hercules has debt investment in 97 companies as of the end of 2020. The average loan has somewhere between 36-42 months until maturity. In all, the loan portfolio is about $2.1 billion.

Hercules holds warrants on 100 companies and equity in 59 companies. The combined equity and warrant portfolio is worth about $260 million right now. According to the company's latest presentation, that is about 20% more than the portfolio's cost basis.

Right now, the yield on Hercules Capital shares is right around 8%

Hercules focuses on pre-IPO and M&A lending to companies with venture capital backing. They have a strong record since their 2005 IPO with $11.1 billion in total debt commitments to over 520 companies. 190 0f their portfolio companies have had an IPO or significant M&A transaction over the same time frame.

I am a huge fan of Hercules Capital, but this is a buy in a lousy market BDC. The shares are trading at the high end of the premium to historical 1.1x to 1.5 times the net asset value of the BDC. If you know me at all, you know that paying a premium of 1.5 times NAV for BDC or closed-end fund shares would cause me to break out in hives and possibly suffer a case of the vapors.

You want to be a long-term owner of Hercules, but you want to be a buyer much closer to the bottom end of that range.

I also like TriplePoint Venture Growth (TPVG). This BDC is lending to pre-IPO companies. Most of the companies TriplePoint lends to are planning an IPO in the next two to three years. They are backed by leading venture capital companies and are well advanced in the growth cycle. These are not startups but established venture capital-backed companies with little to no credit risk.

TriplePoints prefers to invest in the economy's fast-growing segments like e-commerce, entertainment, technology, and life sciences.

Some of TriplePoint's clients have included some of the fastest-growing companies in the world today, including Chegg (CHGG), CrowdStrike (CRWD), YouTube (GOOG), Ring (RNG), and Workday (WDAY).

Much like Hercules, Triple Point usually receives equity in the form of warrants or options in most of the loan packages, so when one of their companies is acquired or has a successful IPO, they ring the cash register. As shareholders, that money gets paid out to us as dividends.

Right now, shares of Triple Point are yielding over 10%. With the shares at 105% of net asset value, I think you can take small positions in this BDC but would prefer to add when we get the inevitable market pullback, and we can take a larger position at a discount.

Owning BDCs for income can allow you to recreate some of the strategies used to power private equity and venture capital firms.

Waiting to do so in a market decline can also allow you to gain a huge edge that gives you high-income streams for a very long time along with substantial appreciation potential.

Posted to The Community Bank Investor… on Feb 26, 2021 — 12:02 PM
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