Specialty lending requires highly specialized skills. That’s why one of Espresso’s key differentiators is our team’s depth of expertise. Because we provide capital to companies seeking to proactively grow their revenue, we have to evaluate opportunities differently than traditional lenders do. That means going much deeper than just looking at a company’s financials. We also have to assess things like its management team, its unit economics and other business fundamentals, as well as the market outlook and any existing investor support. Ultimately, this analysis is essential to determining which businesses will be good borrowers and which won’t.
In this post, we talk to William Jin, Managing Director of Espresso Capital. Will heads up our underwriting team and explains how his experience in venture capital has shaped his approach to evaluating deals at Espresso.
Espresso Capital: Can you tell us a little bit about your experience prior to joining Espresso?
Will Jin: I spent the first 20 years of my career working in corporate finance and venture capital investing. It was through that experience that I learned how to assess investment opportunities across multiple industries, though I spent the majority of my time on technology companies. Over the years, I have made or managed over 50 venture capital investments and sat on over 35 boards, not to mention having evaluated countless other opportunities. Collectively, these experiences have provided me with deep insights on what makes a company successful, as well as what the full range of issues are that can derail companies and prevent them from reaching their potential.
EC: What are some of the lessons that you learned from that experience that you bring to the underwriting process at Espresso?
WJ: First and foremost, is assessing the company’s growth engine. At Espresso, we look for companies that have proven they can scale and do so with profitable unit economics. Typically that means that the company has proven product-market fit, has demonstrated that it can grow in a consistent and predictable way, and has a compelling plan to scale that growth.
Although equity investors can afford to put capital into companies that aren’t growing fast enough or with relatively unattractive unit economics in the hopes of seeing that change over time, that’s just not the case with debt investors. We want to see strong and economically profitable growth right now so that the company will not only continue to succeed, but also service and ultimately repay its loan. There are a lot of companies out there that just don’t meet that criteria, and being able to differentiate between them is key.
EC: What else has your experience taught you about underwriting tech companies?
WJ: Another really big lesson has been the importance of ensuring that founders and their investors are aligned. When everyone’s on the same page, things tend to run smoothly. When they’re not, it can lead to major problems. That’s why a big part of our due diligence efforts is focused on understanding each company’s management team and its existing investors. We want to know the dynamics in play between these parties. A shareholder who has been invested in the business for seven years, for example, might well feel differently about the right time to sell the business or double down on growth than one who invested six months ago. Those kinds of tensions can create dynamics that aren’t healthy for the business. You can be sure that we always want to uncover them as part of our diligence process.
As a VC, I also saw firsthand how important it is to have access to liquidity. Now, more than ever, companies need to have sufficient runway to support their business plans. That means having a number of options, including existing investor support and the ability to attract new investors and interest from potential acquirers. We look very closely at that as we evaluate deals. Likewise, we look at how well companies deal with big events like a pivot in strategy, a shake up in senior management ranks, or the arrival of new investors. Big changes like these represent potential risks. We really dig in and assess how companies are handling situations like these to help us better understand the impact they could have on the company’s long-term success.
EC: That’s interesting. Our last question is about how the industry has evolved. Do you think borrowers’ views around debt have changed and, if so, what role do you think venture debt can play as the marketplace matures?
WJ: First off, it’s important to understand that securing venture capital is often equated with achieving success. This explains the allure of raising equity when debt might be the better option. In this sense, debt providers are competing with equity providers, particularly when a company is flying high. However, as a company matures and entrepreneurs get diluted, using debt as a part of the total capital solution becomes more compelling.
Over the past decade, we’ve also seen the migration of the private equity model to venture capital and growth equity, where the equity sponsors encourage their portfolio companies to use debt as part of their overall funding strategy. In fact, many of the large venture capital and growth equity funds now have capital markets teams to help their portfolio companies with raising capital, including debt.
We also see more situations where debt is combined with insider rounds for companies nearing their exit windows. The main benefit of this funding model is that it doesn’t result in resetting the clock with regard to the exit timing, which inevitably happens when you add a new investor to the capital stack. I think strategic flexibility can be very powerful. And, in the current economic environment, I think debt becomes even more of an option as equity term sheets are hard to come by and valuations are trending downward.
In my view, venture debt has really proven itself to be a viable alternative source of growth financing. And the fact that it complements equity — meaning that it’s beneficial to founders and VCs — makes it a particularly good choice, for borrowers and investors alike.
EC: Thanks for your time, Will. We appreciate the insights!