What you'll learn
- How do you identify them?
- How do you underwrite them?
- How much risk are you prepared to take? Tradeoffs – large deposits vs. higher charge offs
Transcription:
Mary Kay Schneider (00:10):
Good afternoon, we,
Evan Travis (00:16):
This is going to be the fun panel guys.
Mary Kay Schneider (00:17):
We are the survivors here. Yeah,
(00:19):
You guys have lasted a full day taking in all of this new knowledge. We have a great topic for you. It is supporting early stage life sciences and tech businesses. My name is Mary Kay Schneider, and really I'm thrilled to be at this conference. It's the top industry conference for small business, and I have to tell you, I have a little bit of experience in attending this conference because it goes back to the early two thousands. And so I've been to a number of cities and this all started with various roles. At the time, I was a Sales Leader in small business covering a couple of states, and so always looking for those small business sales strategies. Then I moved into a Chief Credit Officer role for Small Business. I was Director of Underwriting and Fulfillment. Then I was coming and I was speaking on topics of commercial real estate more from the credit side. Then following that, I had then moved into a role then when PNC bought National City, which is where I was working, and then had expanded responsibilities into commercial banking as well. And then that became quite large. And then my final stint there was running PPP for the organization and really pleased with how well we were able to support all of those small businesses and their employees. And then I was really ready for a change after PPP and decided to take a role.
Evan Travis (01:52):
We all were.
Mary Kay Schneider (01:53):
Right, yeah, ready for a change. So I took on a role starting up an industry segmentation team, providing sales enablement, sales strategies, product and marketing strategies for six targeted segments. And it also touched upon how business banking could better support women business owners, minority business owners, veteran business owners. So that was a lot of fun, really enjoyed it. And it's just been about a year and a half that I have started my own consulting business. I'm on my own. I'm having an opportunity to learn from other consultants that are the best. And as part of that, then for my organization, I'm looking to help financial institutions with strategies to increase revenues as well as manage risk. And because I have a passion for nonprofits as well, and I've had a fair amount of experience serving on boards, I'm helping them with similar strategies and it shows up around governance and fundraising.
(02:54):
So as you can see with what I described, really, I've spent the bulk of my career in small business. So it is great to be here and I think we have a fantastic topic. I'm pleased to be able to share the stage here with Evan Travis, who's Managing Director of Venture Banking at Live Oak Bank. And our topic with supporting early stage life sciences and tech businesses is one where you've come today because you want to learn some new ways to increase revenues for your organization to be able to diversify those sources of revenues and do that while taking on an acceptable level of risk. So you're going to hear some great ideas from Evan, and I encourage all of you that as you listen to our conversation, that if you have a question, just please raise your hand. We'll get a mic to you. We'd love to be able to just have this be a personalized conversation for all of you really addressing.
Evan Travis (03:52):
I was going to say really quickly too, I'm really glad Mary Kay's up here because Live Oak is huge in the small business space, but they sent their worst representative for small businesses. And me, I really don't work on that side of the business. I'm in the venture banking group, and they are small businesses, but it's sort of a dirty word in the venture space because they're all businesses that are small today that want to be gigantic tomorrow. And so there's a little bit of navigation through that. And I've already apologized to a ton of people being here at Live Oak. I am not a buyer. I'm the lender. I hear about these solutions and they sound like great solutions, but I'm the opposite of the right person for you to talk to. So sorry about that in advance, but really looking forward to the conversation.
Mary Kay Schneider (04:50):
Well, hey, Evan, why don't you go ahead and share a little bit about your background and what's attracted you to doing what you're doing today?
Evan Travis (04:57):
Yeah, absolutely. So I started in banking in 2010. I graduated from MBA school. It was basically coming off the back of the financial crisis in the worst job market in the history. So I had a habit in my career up until that point of taking jobs that were making so little money that people thought I wouldn't take the job. And so coming out of MBA school, I started at the basement as an analyst at Square One Bank, conveniently located in my hometown of Durham, North Carolina. It was a pure play venture bank. So venture lending was all they did, making loans to early and growth stage businesses backed by venture capital firms, PE firms. But it was just a really unique place, square one, super strong culture.
(05:51):
And when I joined the bank between 100 and 200 employees and over the 10 years that I was there, went through going public, grew to a thousand employees, and now have the opportunity to be at Live Oak and have been there for five years. We launched the venture banking practice at Live Oak in 2019. And again, just like the perfect intersection of really quality, highest caliber people and really, really high quality culture. So it's been a fun ride, and I would've never thought that I would've been a banker. It just seems like a super boring job, like crunching numbers. I told my wife when we were early married, my death wish was working a dust job, and now the air conditioning and everything is pretty nice and I enjoy it. But I think venture banking is a really unique place. It's a very relational type of lending. It's not as much box driven as a lot of the small business lending that we've been hearing about today. It's hard to, each business is so unique and their needs are unique. There's some threads that are common throughout in terms of how they raise money, the growth strategies and things like that, but there's a little bit more creativity and nuance to what you're doing. And so I think that creative nature of it is really what sort of drove me to the space and has kept me there. Yeah.
Mary Kay Schneider (07:28):
Yeah, that's fantastic. Well, before I share the points that we're going to cover today, I wanted to talk a minute about why banks would want to get involved in this space. And so if you already have, or it's something that you can buy or you can partner with someone or you can develop expertise in house, there's an opportunity here with greater profit margins and growth that you might be able to see so that you could diversify a portion of your lending into this and be able to see if you're doing it well be able to see some outsized returns, especially as these businesses achieve specific milestones in their plan. And so if you have a well thought out approach and you're committed to it, this is nothing that I would recommend that anyone get into lightly. It really takes the full organization a lot of planning to conduct this and then in a willingness to assess it and modify as you go along.
(08:35):
But when you do this, you'll find that it's a deposit generator for you. You tend to think about the lending side of this. It's very much a deposit generator for you. And additionally, then you have the ability to capture not only that operating business, the treasury management solutions that would accompany it at different points. You might be getting wealth management business. We heard this morning earlier that 84% of business owners are keeping their personal deposit relationship with their business bank. So there's a lot of reason to get involved here in terms of those, the net interest income that you can get from the deposits as well as the fee income that you can generate as well. So let me start first with what we'll cover today. Spend a few minutes talking about some examples of life sciences and tech businesses. And when I say that, because I had been doing some interviewing and networking to find individuals that would be good candidates to talk to about this, they were really wanting to know, well, what specifically are you focused on?
(09:53):
So I wanted to be able to share that so you get a sense of what do we mean here? What's the growth expected? What are some of the challenges in that particular industry, as well as the opportunities, and what are some of those bank solutions that they need? We'll talk about the size and the tenure of these businesses, how they're organized. Importantly, how they're capitalized in terms of what Evan would be able to share through his examples is then talking about what is the niche of some of these particular businesses and being able to share his thoughts on the opportunities in this space. We're going to talk about ways to be able to identify the risk, be able to manage it effectively, be able to mitigate the risk. Then we'll be sharing some strategies on how to engage the whole team to make sure that the bank has an aligned approach.
(10:43):
Also, importantly, how to involve the regulators in a conversation beforehand, how to plan for this, and then how to educate your RMS about this as well as external referral sources so that they can be strong partners with you. So let's talk about the types of businesses that are in the life sciences category. So you'll see here some of the big ones are medical devices, biotechnology, pharmaceuticals. The ones I've bolded here are ones where Evan has some direct experience that he can relay to all of you, but this is a pretty vast area. You'll see in here, nutraceuticals, cosmeceuticals, food processing. The picture that I've got here, if you can see, that is something that happens when you are excited as you're newly pregnant and you're wanting to know about the baby. You've got an ultrasound here, you can see a picture, and the technology has really advanced so that you have greater resolution on these and earlier views.
Evan Travis (12:01):
When we had our ultrasound, it was super creepy. They have the 3D ultrasound now, and it looks like you made your baby out of a hunk of clay, but it's sort of melting is what it looks like. I mean, it's weird. But anyway,
Mary Kay Schneider (12:16):
Claymation.
Evan Travis (12:17):
Yeah, yeah, it's like play baby.
Mary Kay Schneider (12:20):
And so then for technology, similarly, there's a wide range with FinTech, B2B, SaaS, software development, sustainable tech, internet and digital and data and analytics. And so I've got a picture here, and actually I think it can actually be a hybrid between the two. If you think about this wearable device that's right here, that watch, that could be both life sciences and technology because you guys get your heart rate on your watch. Is that something you check in on? I probably check in on that on a regular basis, taking a look at my resting heart rate. Oh, did my workout impact this in a positive way, or, oh, I bet I get to the gym. I haven't been doing this well enough. Another example I'd give you is like, well, can it call 9 1 1 for you if you fall? I actually have on my Garmin, I've got an app that when I'm skiing, if I fall, it will call my emergency contacts and it does work.
(13:21):
I've tested it out fortunately, no major damage. Alright. All right. So I have leveraged a few outside resources, different sources here to be able to provide information about the growth forecast, the size of the businesses that some of the strengths and challenges and opportunities. And so I was looking at resources like IBUs world like Statista, BCG, and McKinsey and Company. And so these are averages. They are point in time numbers and these are wide, there are a lot of things within medical devices, for example, there's a lot of examples of different types of fintechs and B2B SaaS. And with that, you see these averages, but the net profits are strong and you'll have specific areas within that that are much stronger. And that's something that Evan will be able to share more details about. Some of the factors that are driving growth for medical devices include an aging US population, constant advances in technology as well as federal funding for Medicare and Medicaid for fintechs and B2B SaaS. That factor driving growth would be an increasing adoption of mobile devices and rapid digitization. And so you can see the growth here. You've got for fintechs, you've got a growth rate that might be projected at three times that of banks. And you've got an increase in the trust that consumers place in these organizations.
(15:14):
And so you can see strengths and weaknesses of each of these. You'll have these slides available for you for additional information, but there's strong growth present in both of these. There's higher profits than the sector averages. And I would encourage you that you need to understand these items and plan for that. And then additionally, you would want to know that the prospective customers that you're working with, that they are fully prepared for all of this, and they've identified their plans to adapt to changes with that as well.
Evan Travis (15:50):
Mary Kay sent these slides over and I got pretty confused honestly, because these profit margins, and I think it didn't even occur to me, but it's 99% of the loans we are doing, the companies are still losing money. So the profit margin is negative. And so I was thinking we think in terms of gross margin and then we think in terms of burn rate. And so it's like it's interesting to see these numbers. These would be really mature companies. All of the deals that we're doing are still losing money essentially is the That's the space we're in. Yeah.
Mary Kay Schneider (16:36):
Yep. Yep. Alright. So now that we've kind set the table for the conversation, I think it would be great to touch upon a few examples and share your experience with these opportunities. So as you do that, and we've talked about a couple of these examples, I think this is helpful for the audience to have as some takeaways as they think about this segment, the nature of the business, how it was sourced, how was that business capitalized, the structure that was requested and maybe negotiated the types of services sold. I think importantly of course how you monitor those businesses more closely. It's a different type of lending as you and I have discussed before. And then how has that company performed relative to its projections and what's the repayment history look like? So I think the first one you had was they had B2B SaaS with the inventory management.
Evan Travis (17:32):
So a couple of examples, and again, feel free to jump up, holler. I think we have a mic if anybody has questions. But yeah, I mean one of the businesses, this would fall on the technology side for us. I mean essentially at Live Oak we separate the two. We do healthcare and we do technology businesses. It's B2B SaaS business, that's kind of our bread and butter recurring revenues, very important in the style of lending. It's a software that helps restaurants manage their inventory, manage their AP back office sort of mundane functions, but that really move the needle for small businesses. And so this is a venture customer that then is selling into small businesses. In the restaurant space, large majority of our incoming, and really all of our pipeline and incoming referral business comes through the investors. So we are making loans to companies that have raised institutional equity.
(18:43):
And so there are equity sponsors, the VC firms. And so VC firm makes an equity investment into a company. And then in order to leverage that investment that they've made into the company, they make introductions to banks Live Oak, others that do lending in the space. And so it's raising a series a round of capital and either you can raise some additional in debt and that extends the runway and allows those companies to become more valuable, increase their valuations prior to needing to raise an additional round of capital that series B or whatever comes after that. And that's the capitalization of the businesses. I mean, typically the founders are going to own a good chunk at the earliest stages, but most of these businesses are raising multiple rounds of capital. And so over time, that cap table is changing quite a bit. But you think about it, the series A, they're selling somewhere between 15 to 50% of the business probably in that range and usually in the 20 to 25% of the business.
(19:51):
And so a company valued at 20 million, raising $5 million, that's like wouldn't be atypical at the earliest stages and sort of on, and so you're raising a B and it's a higher valuation, and so it's more money, but it's sort of similar. Most of the investors when they're writing a check, they want to own a significant portion of the business. And so in venture lending is, I think this is sort of skipping down to the bottom, the performance of these loans. And I think the thing that most people, you say you're making loans to venture backed companies that are still losing money and burning cash and people are like, oh gosh, you must charge a lot for that to compensate for the risk. And it's like this education piece of these loans, it's super counterintuitive but are not historically do not see higher default rates than your standard small business portfolio.
(20:54):
And so somebody stand up and prove me wrong, but that's been the history of this industry in the venture lending space. And so typically less than 1% annual loss rates on a venture portfolio to date five years into Live Oaks venture practice, we've lost $0 on our venture portfolio. And so I think we, and part of that comes as we're going up the thing, the monitoring, this isn't an SBA loan where you maybe get financials once a quarter, once a year, and you check in with the borrower when they come by or you reach out to them here and there. We're getting monthly financials, we're having monthly calls, we're having quarterly calls with the investors. It is a higher sort of acuity of actually being in tuned to where the businesses are and all the stakeholders around the table, the business, the investors. And so definitely a different type of thing.
(22:01):
As far as structures, it is pretty typical across MO venture banks, but we do growth capital term loans. Typically they're pretty short maturity. So think 48 months around maturities, generally there's an interest only period, call it 12 to 18 months and then you're amortizing the loan. But given the nature of the businesses, you're really not ever super rarely you make a loan and it just progresses through the full life cycle of actually amortizing out. It's like you make a loan and then you're getting out and you're in month 11 and you're coming up against the maturity and amortizing a large loan over three years is super painful. So it's like then they're raising more capital and then we refi the loan, upsize it alongside the new equity coming in, or some of the equity comes in to pay us off before it starts to amortize.
(22:56):
And those are super typical. So growth cap term loan, we do lots of lines of credit, recurring revenue lines of credit where we're lending a multiple of the monthly recurring revenue. We do working capital loans, AR financing and things like that. I mean sometimes there's covenants, financial covenants, like I said, we're getting monthly reporting, we're having constant conversations with folks. And I think it's a very relational type of lending. It's like the opposite of transactional because of all the entities and the webs that with the investors, it's like the investors, you're not just going to have one loan with them. You're probably going to have loans with multiple of their portfolio companies. And this one portfolio company, this CEO, he's 40, he sells his business, he's starting another company and we're going to bank that company on the next go round. And so there's this sort of mutual destruction or we need to act in a way that is predictable and all of these businesses are going to go through hard times.
(24:17):
We don't have a history of performance that shows that this is going, it's like we're underwriting to the future trajectory of these businesses. And so it's like if you've ever seen, I mean every single startup deck you've ever seen has the hockey stick, and it never works like that, I mean 0% of the time. And so it is like there's going to be a period of time where you have less than three months of cash. Everybody's looking at each other around the table and what do we do? And those are where you stand out and you create the relationships with the investors, the companies working with them through some patches and having the experience to know that those ebbs and flows is standard for the business.
Mary Kay Schneider (25:01):
Well, I would think with that too, that just as you mentioned that as that business gets successful and then they sell out and that person's going to, or that team is going to start another business, gives you another opportunity. Plus because you were a bank they could rely on through some tough times through some challenges that helps continue to maintain that relationship.
Evan Travis (25:26):
Yeah, that's absolutely right. And I sort of lost track of the actual example, but I mean this business selling into restaurants and to the gentleman's point on the panel before, I mean it's like they had a loan with another bank, another venture bank, but that bank wasn't being as flexible as they needed in a time period. And so we were able to take that loan out, the equity came in with some equity, we refinanced the loan, gave them a little bit more, gave them additional interest only, and then a year later they raised a big round of capital and we were able to upsize. We went from two and a half to 10 and then they raised again and we went from 10 to 15 and they raised again and we went from 15 to 20. And so that's a very typical life cycle of the business.
(26:14):
If it's doing well, you continue to grow with that business over time and it's a really nice trajectory and sort of that repeat nature and the incumbency of having that loan at the earliest stages allows you to continue to grow with those businesses over time. And you had mentioned on the med device side, Live Oak today, we are five years into this, but we are still, this is, if you're thinking about creating a practice like this in your bank, I mean it's definitely a learning experience and I think where we got folks comfortable was up until a point, but we don't take any regulatory risks today. So no FDA approvals on the device side or the biotech side. My prior banks were one, I mean a third of what we did was biotech. A third of what we did was med device. And a third of what we did is what we're doing now at Live Oak.
(27:10):
And so we did a deal with a device company there. It was a heart rate monitor and it was very similar. I mean they raised a series, we did a small loan prior to the company even getting that FDA approval and then they got the approval raised a larger round to go and commercialize that product, and then we were able to do a loan that helped them commercialize the product, ultimately sold that business for north of 350 million to a big strategic. And so I mean those are the types of deals that you're going to see in the space. And those subsequent rounds of equity is where you get to that deposits that you're talking about because across a portfolio at any given time, some of these companies are going to raise large rounds of capital, and so they're going to be sitting on piles of cash while other ones are going to be in the negative and going to be net borrowers. So they are into our loans, but it's sort of cyclical and across a whole portfolio, typically you would see two to one or three to one deposits to loan outstandings in these portfolios. And so it tends to be a funding mechanism for the other loans that the bank is doing across the portfolio.
Mary Kay Schneider (28:33):
Yeah, Great. Well, there's a couple of points to this that we haven't really touched upon much in terms of providing RMS support as well as thinking through building this cadre of referral sources through that investment community. And what I might recommend, since we are short on time at this point, is that feel free to approach us. Evan is certainly the star of the show in terms of having this detailed knowledge to be able to address those types of questions. But those are both very critical points that you need to build as well as making sure that you've got alignment across your organization and a commitment to it because you can't get into, you have to be very firm in terms of what you are going to lend to much as you described before and what you're not. And you have to stay true to that.
Evan Travis (29:26):
Yeah, you definitely do not want to be a tourist in venture banking. I would liken it to picking individual stocks versus buying a stock indices. If you have a portfolio of loans across the book, then you can weather some of these storms, but if you only have a couple, it's like if one of the goes bad from a portfolio standpoint, you just can't, nobody's going to sign up for that. And so I mean, it definitely is a space that needs sort of broad commitment across the organization, and I obviously can talk a lot, so feel free, I'm approachable after this.
Mary Kay Schneider (30:04):
Yeah. Great. Thank you. I'm going to leave everyone with just the key takeaways here of some steps to follow, to think about how you might get involved in this. If this is going to be part of your strategy to diversify your revenue sources, researching the industry growth challenges and opportunities, assessing the long-term risk adjusted revenue for the segment, determine that fit within your risk appetite, how you're going to measure and manage the risk, developing a plan that aligns your entire team to the opportunity and building a robust risk management strategy, getting support to the RM so that they can confidently refer, and then assessing the results at specific intervals and just modifying as needed. So thank you very much for your time. It went quickly for us and we were thrilled to be able to provide this commentary to you today.
Evan Travis (30:56):
Thanks for hanging in everybody.
Mary Kay Schneider (30:57):
Thank You.