Jeff Pfeffer co-founded CapX Partners in 1999 and serves as the firm’s managing partner and CFO. To date, he and his partners have raised $400 million+ of total capital in four funds. He was kind enough to chat with us recently about the venture debt space and other topics.
Do you see an increase in venture debt usage as part of the trend of companies seeking higher and higher valuations, or what else is driving its popularity?
Active venture debt usage or funding is a function of supply of the capital being plentiful and investors trying to prevent equity dilution. As an alternative to equity investments, venture debt can be an important tool to help with liquidity issues or simply for the company to buy time. The venture debt space is riding the up cycle right now, but a slowdown in corporate acquisitions of newer companies and/or IPO activity decreases could push venture debt usage back down. Venture debt is typically repaid through future cash flow finally generated by a high-growth business or subsequent equity raises. When the economy slows and the ability to exit an investment declines, investors view debt/leverage as a drag to the company’s balance sheet and can cause financial distractions, keeping the company from getting back to expanding, or investing in the business.
Most of the hottest startups these days appear to be in software—do you think there’s a lack of private capital funding innovation in hardware at the early stage?
Quite the opposite. Every day, we see more and more investment focused on hardware startups. Blue-chip hardware companies like Intel, Qualcomm and Dell all have venture arms that invest hundreds of millions per year in both hardware and software early-stage companies so they can be on the cutting edge of corporate and consumer technology trends. When smaller VC focus their investment in software, it’s due to the capital being more controllable and going towards highly scalable business models. You do see more risk with hardware startups due to higher capital investment in factory, equipment and other non-controllable capital investments. Many hardware startups experience difficulty the minute they move into large-scale manufacturing. But now there are also many more resources, experts, and data available to support these hardware startups, fueling growth and helping to minimize risk.
On a related note, are you seeing equipment finance investment stay popular among nontraditional investors or has it been a little sluggish, given slower-than-expected growth in the U.S. in 1Q?
Equipment finance attracts certain investors from both the conventional (banks and publicly traded financing companies) to non-conventional (private funding vehicles, lease/loan funds, hedge funds). Q1 2015 was slower for CapX as compared to the flurry of activity at the end of 2014, but has regained momentum in Q2; we’ve found this to be consistent amongst our bank and non-bank peer group. Activity appears to be more sector-specific with one highly visible downturn in oil and gas production/servicing.
One area that is currently showing strong growth includes several subcategories within the food sector. Natural, organic, non-GMO, gluten-free products, plus an increased emphasis on ethnic foods as well as snacks and prepared foods. These categories relate to the increased consumer focus on health and wellness, combined with the need for speed…wanting food items that reflect today’s busy lifestyles. Many of these producers outsource to contract manufacturing. These companies don’t necessarily want to buy new equipment just for these experimental new brands; they’re looking to transfer risk by leasing equipment rather than own.
3D printing has been heralded as an exciting trend in equipment financing—particularly with regard to distribution. What’s your take on the future of 3D printing with regard to your business and what are some other trends you think are exciting in equipment finance currently?
We have not deeply studied 3D printing and still see it as a nascent cottage industry. With that said, it has strong potential to be a disruptive industry should these printers be able to produce parts and products on demand and with lean, just-in-time components that satisfy internal or external customer needs. Taking that a step further, traditional supply chain and other vendor-dependent businesses could be replaced by 3D printer warehouses. These warehouses could be used to support a company internally, or become niche product providers on their own.
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