Red Herring

VC Firm Tries Loans

Charles River Ventures tries lending strategy as a way to provide seed funding to

November 1, 2006

Charles River Ventures introduced a lending program Wednesday as an alternative way to providing financing to promising startups.

The firm, based in Waltham, Massachusetts, and Menlo Park, California, debuted CRV QuickStart, a seed-funding program that aims to help entrepreneurs develop prototypes of their new ideas, such as tech product, and launch them quickly.

The loans, of up to $250,000, will help entrepreneurs build on their concepts and explore the market potential for their products as they prepare for a formal Series A equity round. The QuickStart financing could also appeal to entrepreneurs who are concerned about equity dilution and losing control over their companies to a VC firm.

George Zachary, a general partner at CRV, said the last four of five companies that CRV seed funded had participated in the lending program. ¡°We decided to formalize this program and accelerate the development of a lot of cool companies,¡± he said.

He declined to provide details about the companies since they are still in stealth
mode, but said that one was a semiconductor intellectual property company and the other three were Internet-related companies in the ecommerce, social networking, and mobile arenas.

He believes his firm¡¯s QuickStart program will accelerate the process for launching new ideas and getting an early evaluation of their potential, so entrepreneurs can gain a time-to-market advantage over the competition.

Alex Bangash, managing director of Rumson Capital Advisors, likes the idea of CRV QuickStart. ¡°It would allow CRV to establish a lock on the really good deals that would be intensely competitive in Series A, but that are too early for most VCs,¡± he noted. ¡°Moreover, sometimes the truly outstanding entrepreneurs are not ready to raise Series A because they don¡¯t see the true potential of their ideas and do not want to dilute their company at that early a stage.¡±

Staying in Stealth Mode
The loans, in the form of convertible notes, don¡¯t require any public filing so startups can stay in stealth mode, which helps keep their ideas a secret. The entrepreneurs avoid personal liability by setting up a corporation. CRV will even set up the corporation if the entrepreneur doesn¡¯t already have one. ¡°One of the key benefits of this program to the entrepreneur is stealth,¡± said Bill Tai, another general partner at CRV. ¡°These days it¡¯s a matter of fact that companies can get started on commodity technology. With viral marketing they can get launched on very little capital, so time to market matters more now than ever.¡±

After making the loan, CRV then works with the company by taking a seat in an observer capacity on the startup¡¯s board and helps assemble the initial formal round of equity financing when the time is right. The goal is to convert the debt into equity if the company succeeds in getting a Series A round of funding.

CRV has been making loans of this type to various startups including Internet companies, but it has now decided to formalize the program with QuickStart. Over the past year roughly a third of the projects the firm has committed to have been seed projects.

If the startup wins Series A financing, CRV said it will ensure that all the parties that helped build the company will be appropriately rewarded for their contributions. That includes professors, mentors, the person who brought the project to CRV¡¯s attention, and institutions such as universities, foundations, nonprofits, and industry groups.

The lending program helps eliminate some of the risk for the firm too. Some VC firms believe there is too much venture money sloshing around in unpromising companies. In at least one case, a prominent firm, Sevin Rosen, recently decided to cancel a fund it had raised and send the money back to investors (see VC Firm Sending Cash Back).

Streamlining the Funding Process
Mr. Zachary said that CRV wanted to fund entrepreneurs in a way that banks could not, and to help them avoid the trouble of wooing angel investors.

¡°This is a way for us to seed finance entrepreneurs that have a cool idea,¡± he said. ¡°We¡¯re not asking for any equity in the proceeds, but we will convert the loan to equity when they raise a venture round.¡±

He likens the business model to a combination of angel investing with the backing of a venture firm. ¡°What we ask for is the right to participate if the entrepreneur raises a venture round on an equal basis with other investors, but not a controlling position,¡± he said.

If the company fails to raise a venture round, then the company can pay back the loan, with 6 percent interest, in a year. Internal Revenue Service rules forced CRV to set a rate so the loan would not qualify as a gift, but Mr, Zachary emphasized that CRV did not intend to act like a bank.

¡°The intention is not to make money off the interest rate,¡± he said. ¡°The intention is to get access to a broad array of interesting companies and participate in many of those as well.¡±

All Rights Reserved © Copyright 2008-2009 Rumson Consulting Group
Buyout News 2008
Alex Bangash quoted in Buyouts
Wall St. Journal India Livement 2008
Alex Bangash quoted on India PE environment
ALT Assets Interview
Rumson profile in Altassets...
Venture Capital Journal
Rumson cited on China Early Stage Venture...
Endowment and Foundation News
Rumson cited in Endowment and Foundation News...
Red Herring
Rumson mentioned in Red Herring on Charles River Ventures program...
Wall Street Journal
Rumson data cited on Emerging VC managers in WSJ...