September 12, 2024 | Insights

Debt Financing for Deep Tech: CapEx Sales Model

Venture Banking

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By Matt Trotter, Managing Director, Venture Banking

Discover how a revolving line of credit can help smooth working capital swings when selling in a CapEx revenue model.

What You Need to Know

Many deep tech companies still prefer the traditional CapEx sales model, which involves full payment upon product shipment and shorter working capital cycles.
To manage working capital needs in the CapEx model, companies use a revolving line of credit to cover the gap between paying suppliers and getting paid by customers, typically ranging from a few weeks to six months.
Deep tech companies need to engage early with lenders and understand the borrowing formula in order to secure the necessary funding, optimize contract terms, and avoid cash flow issues during commercialization and scaling.

While the Hardware as a Service (HaaS) model is gaining popularity, many companies still prefer the traditional CapEx sales model. In this model, companies pay manufacturers in full upon product shipment, with an ongoing maintenance/software revenue stream that is much smaller as a percentage of total revenue.

Compared to HaaS, CapEx working capital needs are shorter but can still be significant as the company scales. To address these needs, companies often use a revolving line of credit, which bridges the gap between paying suppliers and receiving customer payments, typically ranging from a few weeks to six months.

This line of credit is governed by a borrowing formula that determines the advance rate per asset type. This formula tracks the life of an order from the initial inventory purchase until the customer has paid in full, giving higher advance rates for assets later in the sales cycle. For example, inventory will have a lower advance rate than accounts receivable because an asset becomes accounts receivable once the product has been shipped to the customer.

Read the previous article in the series: Debt Financing for Deep Tech: Hardware as a Service Model

Who Should Consider a Revolving Line of Credit?

As a deep tech company moves into commercialization, it is essential to meet with lenders to understand the options and criteria for establishing a revolving line of credit. Waiting to put a debt instrument in place once a company has a large order is like flying a plane while building it. Waiting to establish a debt instrument can lead to missing customer timelines or needing to renegotiate contract items to access financing.

“Hardware founders are often surprised how quickly they need more cash,” says Zachary Kimball, founder & CEO of Hardfin, a software company that supports financial operations for deep tech companies. “The time from procurement to build to deployment just has so many variables at the early stage. Like most startups, things never go according to plan—but the implications on capital needs are much more profound for hardware companies.”

The amount of debt needed to support a working capital need is greatly dependent on the structure of the contracts with suppliers and customers. A company should seek to improve its terms with suppliers and customers to limit the need for debt as it scales.

Case Study: A Semiconductor Company Pursues a Revolving Line of Credit

Company secures a $20MM revolving line of credit from Stifel Bank to finance its working capital needs. The facility has a 50% advance rate on purchase orders and an 80% advance rate on accounts receivable.
Company receives a $15MM purchase order for their semiconductor chips from a large cloud storage provider.
Company borrows $7.5MM on the revolving line of credit to pay their contract manufacturer to produce the chips.
Ninety days later, the chips are delivered to the end customer. The purchase order converts to accounts receivable, and the company can advance an additional $4.5MM, bringing the total debt outstanding to $12MM or 80% of the contract amount.
Sixty days later, the customer pays $15MM in full. The $12MM in debt is paid back, and the remaining $3MM is distributed to the Company.

Key Terms and Features

Typically, venture banks provide revolving lines of credit to deep tech companies. These banks understand hardware companies’ cyclical and capital-intensive nature and can offer tailored financial products to support their growth, along with other banking services and products.

Typical Revolving Line of Credit Terms

Structure: Revolving, which means the borrower has the ability to pay down and borrow up on the facility.
Commitment Amount: $1MM-$60MM
Borrowing Formula: Lender advances a percentage against inventory, purchase orders, or accounts receivable. Typical advance rate is 50% on inventory and purchase orders and 80% on accounts receivable.
Maturity: 1-3 years
Repayment Period: Interest only during monthly, principal due at maturity
Interest Rates: Typically set at the WSJ prime rate plus 0.5-1.0%
Warrants: Typically no
Covenants: Sometimes
Lien: Blanket lien on all assets, excluding IP

Best Practices for a Revolving Line of Credit

Plan Ahead of Contracts: If you’ve already secured a scalable revolving line of credit when you finally close a large contract, your company won’t be scrambling to find cash to fulfill the contract. Instead, you’ll be ready to execute and deliver, leveraging your existing financial structures.

Understand the Borrowing Formula: Understand the borrowing base formula and what assets are included or excluded. For instance, international sales or inventory in transit might not count toward the borrowing base.

“It’s important for finance leaders to understand both the availability and the timing of credit,” Kimball adds. “How much can you draw and when? Both of these are related to the borrowing base and borrowing formula. A strong financing partner will make both of these very clear, in the negotiation and in their docs.”

Anticipate Partnership Needs at Scale: As your company grows, the scale of your financing needs will also expand. Most banks have a cap on how much they can lend, typically around $60MM. Anticipating this limit and planning how to engage additional banking partners or financing solutions can prevent growth bottlenecks.

The Path Ahead

By understanding and strategically leveraging a revolving line of credit, you could be well-positioned to capitalize on opportunities and drive sustained growth.

With Stifel Bank Venture Banking, discover a partner who can provide you with the expert guidance and tailored financial solutions necessary to navigate the complexities of CapEx lending.

Talk to Stifel Bank Venture Banking deep tech financing expert Matt Trotter at mtrotter@stifelbank.com.