E310 | EUVC | David Bateman, Managing Partner at Claret Capital Partners on European venture debt in different market conditions

0:00Welcome back, everyone, to another exciting episode of the European VC podcast. Today, I have David Bateman, Managing Partner of Claret Capital Partners with us. Claret is a European growth capital fund, and they're on their third fund, the 297 million euro fund with 700 million in AUM. They're headquartered in the United Kingdom, so UK guys, as we've had so many of on the podcast. So please, if you're not from the UK, feel free to reach out. we'd love to bring more of the European diversity that we have on the podcast. That's a big shout out to all of you out there. Do let us know about what you're building.

0:39They are focused on growth stage and VC-backed companies, typically post-series B. They're a debt provider, and they're primarily focusing on Europe. They're focusing on technology and life science companies, and they're backed companies like Abivax, Barternox, Box, Hoolidoo, and Veed. So you're in for a big, big episode only on the debt landscape in European venture. I hope you will enjoy it as much as I did. It was quite the masterclass. Here's a few words from our beloved sponsor. Welcome to a special episode of our podcast, proudly brought to you by 0100 Conferences. Join us for a unique networking opportunity like no other at the 0100 Conference CEE.

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2:07It's more than a conference. It's where the future of finance takes shape. Save the date and join us in Prague. To learn more and register, visit our website linked in the episode description. See you there.

2:22Tear down this wall. It's more than just an alliance. This is a union of values. United and determined we can serve as a model for other regions of the world. The nature of a problem requires a European response. Europe is a story of new beginnings. Let's start acting. This show is not investment advice, and the hosts of this episode may be invested in the funds and companies featured. All right, David, welcome to the European VC podcast. Hey, Andreas. Good to be here. Thank you very much for having me. Of course. And I've been looking forward to this because we're going to talk a ton about debt in European ventures.

3:09But before we get into that, let's just share a bit of light on who you are as a person and how you've come to be where you are today. Thanks. So, look, my journey really started in the 90s. I was working in a tech investment bank called Broadview, which at the time was probably one of the larger outfits focusing on selling technology companies on behalf of European entrepreneurs. And my first exposure to venture came in 97 when they decided to set up a venture capital firm within Broadview in partnership with Electra Fleming. And so my first exposure was really helping put together some of the documents and some of the research work for what eventually became Kennet, which is a well-known investing firm in the UK and across Europe now.

3:59And the genesis of that is really what taught me about venture. After that, I started helping Broadview focus its efforts on the VCs, effectively as clients. So we would build a relationship program to the VC market as it was growing in the late 90s. And come early 2000s, the M &A market was not so hot. And some people I knew were setting up one of the first venture debt operations in Europe. And so I joined them in 2002. And that was my journey really into the industry full time. and I suppose also my journey from being an advisor to being an investor. And that's how I came really to be involved in this whole industry and I've always been on the debt side.

4:39I mean, one of the reasons for doing that was, you know, my background was really finance and economics and so on. And it was probably, I thought, a better mix long-term to be involved in some of the financial engineering for technology than maybe to try and go in and guess the technologies myself. That decision has worked out okay. And here we are, 20, whatever it is, 22 years later. And I'm one of the co-founders here of Clarit, which is a player in the European venture debt industry. Note to audience, Clarit. I've always, for some reason, pronounced it Clarit. So I might make a slip up there, but just emphasize it's Clarit.

5:18So, David, for today's conversation, we're going to dive into, as I just said, the market of debt in Europe. And I really just want to get us off by asking you to tell us how have you seen it develop since you started up until today? I think that's the right place to embark on this. So the core of what we do and what debt, the role it plays with these venture-backed businesses is it's essentially an anti-dilution tool. You know, like everybody else in the ecosystem, we depend on one core thing that happens that we don't control, which is an entrepreneur starts a business. and like everybody else, be they VCs, be they service providers, etc.

5:58We depend on that core spark, which is when some brave person decides I'm not happy with the way this or that task or technology or service or product is being provided in the marketplace and I want to do it better. And from that spark comes a business and that business goes through. Usually it needs outside money to get going at some point and how it gets that money is a journey. and we are one stage, sometimes a couple of stages on that journey. And so, you know, where we fit really is in the marketplace once these companies have actually become businesses. I mean, we sometimes are used a little bit earlier or some people will use debt perhaps a bit earlier than that.

6:41But in my experience, it's pretty mixed risk. The thing that's different about debt relative to, let's say, equity is you can actually damage a business if you do it too early. I mean, that's the one thing about debt. The Germans have a great phrase, fremdkapital, foreign capital. And that is the truth of debt. It's outside money that ultimately has to get repaid at some point. And so the timing of it is pretty critical, which is that makes it different to equity, where there isn't necessarily the presumption of exactly when it's going to get repaid. And that decision is the core of what we do and what the entrepreneurs do.

7:18So you have an ecosystem like Europe's, which is a little different to the US because in Europe, innovation starts all over the continent. So it's very dispersed. So companies get started in Finland. They get started in Oulu. They get started in Helsinki. They get started in Galway. They get started in Sofiantipolis. And all of these different European clusters are quite distinct from each other. And they're also crucially in different legal jurisdictions, which again is different to the states where largely they're all under the same basic rules. That affects the flow of capital to them. And while Europe and equity flows the same way across most of these borders, debt is a little bit different.

8:00Debt investing is sensitive to bankruptcy rules. It's sensitive to regulation. It's sensitive to all kinds of other factors, cultural factors as well. And as a result, the debt markets are somewhat more fragmented in Europe than they are in the US. From the entrepreneur's point of view, the person who's started this brave journey and has decided to build a business, exactly where they are going to use the debt in the mix is a big decision. So we certainly believe that they should be using this when they have a relatively proven business model, when they have customers, when they have growth momentum, and when they have pretty strong gross margins and gross margin stability.

8:38So they know that if you add capital, it's going to grow and prosper. And that also goes for the venture capital firms. Usually, by the time we see a business, the venture capital firms have already invested in it once, maybe twice. And they will also be looking to optimize their position. And from their point of view, the venture capitalist point of view, it's always really a decision. It's do I really want to use my LP's money or do I want to use somebody else's money? And that's a judgment call for them, too. And they have to judge those risks. And they're also exposed just like the entrepreneur is exposed.

9:10But the same logic applies. If they can structure a deal where the loan doesn't add tons of additional risk to the business, and that usually means taking a smaller loan than some people would sometimes like, then, in fact, they can progress the business without taking huge risk and without taking huge dilution. And that's the zone in which we operate. It sounds simple in a way. In reality, getting it right, we get it wrong every day after doing it for 20 years, and so do others. And so it's quite a fine judgment. So you find that sometimes the reputation of venture debt can be a bit mixed. Very often people, especially if they've gone through a cyclical peak like 2021, some people are struggling with it in some of their companies.

9:54But this time, this moment that we're at right now is actually a fantastic time for both user and ourselves, because at a time when valuations are somewhat depressed, as most people would probably say they are right now, this is a moment in which we add quite a lot of value to the situations where we work. And so from the entrepreneur's point of view, from the VC's point of view, if the burn of the company can be controlled, if it can be kept growing without burning enormous amounts of money, we can add a lot of value. We can buy it a lot of time and a lot of runway for it to achieve things, develop, et cetera, because these companies are maturing at different levels in different ways.

10:35And very often, some of the maturation is internal or it's in the organization or it's in the deepening of customer relationships. And these companies are trying to win more dollars out of their customers. That process can often just take time. And that time is something that we can buy for these companies. So that's how it works. And I hope that isn't too circular for your readers and hopefully write notes or your listeners. And hopefully we can write notes that help them follow that. When we think about that timing issue, it being so crucial that you take on VentureData at the right time. How does that differ across verticals?

11:14Because we know the venture book is quite different whether you do deep tech or you do SaaS as an example. What you look at is completely different. What you expect is completely different. Of course, you're looking for similar outcomes when it comes to the financial returns. But what you're looking at when you're evaluating the individual opportunity is completely different. How does that look for you as a venture debt provider or investor? How do you judge and make sure that Claret can actually both fund SaaS businesses and deep tech businesses? Or do you stay out of deep tech and say, until there are customers, which there's often not in deep tech until you're quite far down, we're not the partner for you?

12:04How does that work? The dynamic that the entrepreneur probably wants to think about is, what do I control? What do I not control? And the bit that I want that I don't control, how predictable is it? Where people get hurt is if they have burn levels, and then they have revenues that don't arrive. and either revenues that don't arrive or margins that change. Most of the time, the margins are known. I mean, usually the business has had a go at commercialization. If a company has never commercialized, it's pretty dangerous to look at debt because you really just do not actually know what this service or product that you've innovated, how it's really going to perform in the marketplace.

12:44You think you have pricing power. Most entrepreneurs believe their stuff is amazing, and most of the time it actually is. But exactly what pricing power comes with that and what margins you're going to get until you've actually launched and you're in the market, it's really hard to know. So I think pre-revenue with our type of business is pretty tricky. Once you're in revenue, I think it's a question of the underlying pattern more than the sector. So we have done, you know, we've had a very good experience with a robotics business. We've had a very good experience with a satellite business. But at the times we did those two businesses, they were engaged with multiple customers on multiple projects.

13:23A lot of those projects were quite small. And the companies themselves weren't that large in terms of total size. They were both, I think, sub-5 million revenue businesses. But what was important was in the underlying pool of customers that were driving the revenue forecast, there was a significant spread. And so the behavior of the aggregate of those revenue opportunities was to some degree predictable, because you might be wrong about 5 % or 10 % or 15 % of them, but you weren't going to be wrong about all of them. And if you'd been in the market for 18, 24 months, you had some data to tell you how your customers are going to behave in terms of buying and coming back to buy again.

14:01On the other hand, if you're a business and you've got one big customer, like, for example, you're selling to the health service, your only customer is the UK or the German health service, and you're entirely at the mercy of procurement in one organization, then the debt is pretty risky, even if that opportunity is huge, by the way, because everything is on, it's like the roulette wheel where everything is on one color. And that's more the dynamic than whether it works in SaaS or whether it works in deep tech or whether it works in robotics or whether it works in e-commerce. It's more a question of how broad are the number of sales opportunities because the bit of your P &L you don't control is usually the revenues.

14:43The costs, on the other hand, for most entrepreneurs, most of the time, are known and to a certain degree controllable. If they have to trim them, they can trim them. It probably costs you more money or less. If you're in France, it costs you more than it probably costs you in the UK. But nonetheless, in the medium term, you can change your costs and you can adjust. But where you get stuck is if you're bought into a cost level and then you have a revenue level and then you have a debt schedule that has a repayment date on it, that's the danger zone. What we look for is granularity in the business model.

15:15We do all kinds of sectors. We do a huge range of sectors for a firm of our size and with our skills. But what we look for is the granularity in the business model. And that is where both we and I would think the entrepreneur is fine in the common zone. I think in most European countries, we have the likes of in Denmark, it's the Eiffel, former growth fund, Danish growth fund, who are a big lender to startups. Is that the case in almost all geographies, that there is a government-backed entity that basically competes with you? It's certainly the case in Denmark, and we've managed to do stuff with VEX funding also in a way as a partner where we've been in the same deal.

15:59It's also the case in France. It's not really the case in most other European countries. The UK doesn't really have a state-run debt fund. We have some of the US, some of the UK government institutions are investors in our fund and they invest in our competitors. In other parts of Europe, you get aspects of it. But you have, for example, in Germany, you have high-tech Grunderfonds, but fundamentally, their product is a convertible. It's really an equity product. It's not really a debt product. So by and large, the answer to that question is not really. There's not as many state-owned lenders as you would think.

16:36But there is quite a lot of state and government support for venture lenders, for which obviously we're quite grateful, as is the venture capital industry. And it tends to be some of the same groups as are in the venture capital industry. And if I asked you just to map out the European ecosystem on the tech lending or the debt side, who are the main players that you'd say that on a pan-European level people should be familiar with? I mean, the three players that we've that have competed together for the bones of 20 years would be, I mean, what was previously known as Krios and it was acquired by BlackRock last year.

17:12What was Silicon Valley Bank and was acquired out of its issues by HSBC. There's ourselves. And then there's a number of other smaller players, some of whom specialize in tech, some of whom specialize in life science. We do both life science and tech, I should say. And then locally across Europe, you have a number of other players. Very often you have, you know, revenue based lenders who are also part of the landscape but have a significant role to play. And those revenue based lenders, you know, they vary a bit by geography, but there's some of them present in most geographies, certainly the larger European countries.

17:51And then the banks, a number of European banks also have made use of guarantee programs from the EIB or the EIF to launch lending programs. So there's quite a lot of competition. I mean, it's not unusual for companies to have four or five options. Exactly how useful all those options are depends a little bit on their structures, their timing. Some people have flavors. We do pretty much a bit of everything, but some people focus on one sector and some of the revenue-based lenders will only do e-commerce. Some of them will only do SaaS. So it's a mix, but there's usually most companies have multiple options.

18:29Then when a VC is helping their portfolio company at Series B figure out who should they partner with around the debt, how should they think through this? You've gotten to the stage where you have three different offers. What are the factors on which you typically compete? So speaking for Clarice, you know, our specialty where we can is to bring these companies into the fund relatively early, lend what we call growth lending. So you're lending essentially for the organic burn of the company anywhere from one up to about 12 or 13 million euros. And then you're also there for the later stage when those segments start to consolidate and you can provide acquisition based financing.

19:12And that's quite a significant part of our business. There's other flavors of situations. You know, at the smaller loan end, you know, there's a number of there's quite a number of options. And, you know, we lose a lot of deals to competition. And, you know, there are some good players in that space. They can speak for themselves. And I think they provide interesting options to the VCs. And the VCs and the boards are quite disciplined and they do the right thing by the company. They seek competitive offers, and the majority of our deals are won in some form of competitive tender. The thing I think that people maybe don't always focus on, perhaps, is the stability of the partner and the ability of the partner to grow long term.

19:54Most entrepreneurs are not just thinking about this year or next year. They see themselves as growing large businesses, and that's the entrepreneurs that we want to work with. And in that sense, you want to work with a player who can go all the way with you. But a lot of people disagree with that. And they say, I want the terms for today and I want to optimize. I have three people in the hoop and I want to optimize the terms. And sometimes that's the right thing for the company and the right thing for the board. And so there's quite a healthy competitive environment in most of Europe from the company's point of view.

20:25And they have options. But where we're focused really is high quality businesses with really distinctive, if you like, alpha or distinctive pricing power because they've innovated in some really special, distinctive way that we think can go all the way, we think can be consolidators. Because if we can put a consolidator, you know, we've only got so many days in the year to add companies to the fund. We're a team of 24 people. We have time to do maybe 20 to 30 companies a year. Our biggest challenge is to put the companies in the fund that we can do the second stage with, the ones that we can grow all the way with.

21:04We want to find those companies and we want those companies to find us. And where we can, we want to bring them into the fund because we will be able to support them through multiple rounds as they go through a longer, longer journey. That's when our business is efficient, both for us and for the wider marketplace. But it's a competitive marketplace and there are people and there are options and players out there who will do deals on different terms. And sometimes that is the right thing for the company. So we lose a lot of transactions. Could you concretize for us what are the terms that are being moved on when you're considering different tenders or different offers?

21:45What are the things that you can move on? So you obviously had the interest rate, you obviously have the payback schedule, all that stuff. What are the elements that you win and lose deals on? We would have equity kickers in all of our deals, and that's really the hallmark of venture debt. Some of the bank-funded deals are probably less focused on that, and some of the revenue-based lenders don't have warrants or equity kickers in their economic models at all. they will charge, generally speaking, higher yields, significant fees. They'll also be much shorter term. But if you have a large business that is seasonal, for example, an RCF, a revenue-based lender, is a great product.

22:29It's a great solution. You can also mix and match these solutions. As the companies mature, you can have more than the collateral in a business, the assets in a business, they don't all have to be pledged to the one party. Even though we competed with Silicon Valley Bank, we had numerous cases where we would be in a deal with them and they would have certain parts of collateral and we would have other parts. And so you can, as the businesses mature, have different players. We're bidding a French deal right now where there's a BPI loan in there. You asked about lenders and state loan lenders. There's a BPI loan in there, and we're leaving that BPI loan in.

23:13So it isn't an exclusive situation, but at the smaller end of the deal, you want simplicity. And so it tends to be a bit like a Highlander movie. There can be only one. At the larger end, it's a more sophisticated marketplace. And actually, there's scope for different types of solutions. Just like in a mature business, you might have different types of lenders for different asset classes in a business. You can have the same thing in these businesses when they get larger. And so in that acquisition finance end, for example, we've often found small banks alongside, RCFs alongside, other products, asset-based lending, quite a long list of alternative forms of debt in these businesses.

23:57And we're quite commercial about that, and so are the companies. It's not the most exciting thing, Andreas, to be honest. I don't think the CFOs get up in the morning and say, this is a really exciting way to spend my day. But it is quite useful for the companies in terms of - CFOs do, but the rest of the company doesn't. Perhaps the CFOs are more enthusiastic. They'll be super excited. So the managing has moved on. But like all companies, there's specialization in roles as you scale. And that's just maturing of a business. But then if we switch to the LP perspective, what is it that characterizes a debt offer or debt fund versus a normal equity venture equity fund?

24:39So the debt LPs are a little different to the equity LPs. And I know that this is a big theme for a lot of your listeners and the venture market is going through quite an interesting time with fundraising at the moment. And so is the debt market as ever, but they are a little different. So, I mean, debt limited partners are looking for deployment. They're looking for stability in returns. They're not necessarily chasing higher IRRs everywhere across the board. They want fairly straightforward drawdown and repayment schedules. there's an aspect where they will prize predictability and capital preservation above, let's say, every last dime of IRR.

25:24And that is a little bit how debt LPs think, which is a little different to equity limited partners. We focus on, we in terms of as a provider of a product to those LPs, we focus on a diversified pool of companies. We put 60 to 80 companies in a fund. We don't really lend. I mean, although we have limits, we end up well below those diversification limits. So we don't even come close to our diversification limits in terms of how we build the portfolio. We try to do multi-stage as well. Like I was mentioning earlier, we try to have a mix of companies where you're recruiting companies in, but you're also going to have a mix of later stage acquisition finance in there in terms of the risk profile and the maturity profile of the deals.

26:09and you're producing essentially a lump of cash flows back to a pool of investors, which is much more diversified and much, however, it needs to be much more stable. So we pay out a regular yield to our investors. So most of the interest that comes into our fund goes out to the investors every quarter. So they get a very stable yield and they get relatively predictable pay downs. They get quite high DPI. I mean, the one thing that our industry produces, which venture is probably struggling with, is what you'd call DPI distributed to paid in. So we do provide a lot of cash distributions back to the investors.