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 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. Still, the custom-made equipment 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 of 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 have negative cash flow, and 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 cannot move. Many of them know that a small percentage of the underwrite transactions 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 Owner Business.
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?
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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. The vendor can often 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 lobby for special re-marketing arrangements as a purchase incentive.
Consider other assets that the startup might pledge to support the transaction. The financing source’s main concern is the ability to exit the transaction should the startup default in making payments. By offering additional collateral to support the transaction, the startup may alleviate or greatly reduce this concern.
Try to schedule custom-equipment purchases and other equipment with an established aftermarket, such that the custom-equipment represents a minority of the equipment being acquired. Similar to offering additional equipment as collateral, bundling custom-equipment with readily re-marketable equipment, the bundle’s overall collateral value 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.