A Much Safer Way to Get a Piece of Pre-IPO Companies

Last week we took a look at some Business Development Companies (BDCs) with close ties to private equity firms. 

This week, we are narrowing our focus on BDCs that have venture capital type exposure. 

There’s no debating the fact that venture capitalists have been crushing it for the last decade. We hear success stories every week and there are no signs of it stopping any time soon. 

What they don’t tell you about venture capital though is that 75% of all startups fail and more than a third of these failures are a total loss for investors. Your odds as a venture investor of hitting a home run are minuscule at best.

But what if there was a way to receive income while at the same time participating in the massive potential of trends such as artificial intelligence, driverless cars, cybersecurity, digitally enhanced supply chains, blockchain, software as a service and all the other breakthroughs that print billions of dollars for venture capital investors?

There is, and that is what we are going to focus on today. 

You see, there is a group of BDCs that are lending money to technology companies before they go public. Often, they will get warrants and options as part of the loan package so they can participate in the upside as well. 

These BDCs are part lender and part venture capital in many respects. 

Lending to potential unicorn companies and taking some equity exposure as part of the package is a much more consistent way of being a conservative-aggressive investor.

Combining Venture Capital and Income

Hercules Capital (HTGC) is a BDC that focuses on life sciences, software as a service, renewable & sustainable technology and a catch all bucket they call special situations. 

The company focuses primarily on pre-IPO and M&A lending to companies with venture capital backing. They have a strong record since their 2005 IPO with $11.1 billion in total debt commitments to over 520 companies. 190 of their portfolio companies have had an IPO or major M&A transaction over the same time frame.

At the end of 2020, Hercules had debt investments in 97 companies. The average loan has somewhere between 36-42 months until maturity, and the total loan portfolio is about $2.1 billion.

With a market cap. of $1.82 billion they are the largest BDC catering to high growth VC backed companies.

Hercules holds warrants on 100 companies and equity in 59 more. The combined equity and warrant portfolio is worth about $260 million right now. That is about 20% more than the portfolio’s cost basis according to their latest presentation.

Right now, the yield on Hercules Capital shares is right around 8%

I am a huge fan of Hercules Capital but this company should only be added to your watchlist currently. The shares are trading at the high end of the premium to net asset value of 1.1 – 1.5x historical range. 

If you know me at all, you know that paying a premium of 1.5x NAV for a BDC would cause me to break out in hives and possibly suffer a case of the vapors.

You want to be a long-term owner of Hercules, but you also want to be a buyer much closer to the bottom end of the NAV range. 

Your chance to grab a piece of Pre-IPOs

Another venture capital-like BDC to take a look at is TriplePoint Venture Growth (TPVG).

TriplePoint lends primarily to pre-IPO companies in which most are planning an IPO in the next two to three years. The companies are backed by leading venture capital firms and are in the breakout phase. These are not start-ups, but rather established companies with little to no credit risk.

TriplePoint prefers to invest in fast growing segments of the economy like e-commerce, entertainment, technology, and life sciences.

Some of TriplePoint’s clients have included some of the fastest growing companies in the world including Chegg (CHGG), CrowdStrike (CRWD), YouTube (GOOG), Ring (RNG), and Workday (WDAY).

Much like Hercules, TriplePoint usually receives equity in the form of warrants or options in most of the loan packages. When one of their companies is acquired or has a successful IPO, they ring the cash register. The best part is for shareholders in the company as that money gets paid out to us as dividends.

Right now, shares of TriplePoint are yielding over 10%. With the shares at 105% of net asset value I think you can take a small position, but I would prefer to add at a discount when we get the inevitable market pullback.

Owning BDCs for income can allow you to recreate some of the strategies used to power private equity and venture capital firms.

Waiting to do so in a market decline can also allow you to gain a huge edge that gives you high income streams for a very long time along with substantial appreciation potential.

– Tim