2 tech stocks with returns of 9% and above
Co-produced by Austin Rogers
When most people think of venture capital, what comes to mind is “high risk, high reward”. What if I told you that there is a form of venture capital that offers high returns and much less risk than the average venture capital investment?
Enter “venture capital debt”. There are a handful of business development firms (“BDCs”) that specialize in this small and growing asset class. Two of the best companies in this field are:
- Hercules Capital, Inc. (HTGC)
- Trinity Capital Inc. (TRIN)
Over the past few years, as the investment community has voraciously sought to allocate capital to the venture capital industry, these two BDCs have performed phenomenally.
But during the market sell-off over the past few months, HTGC and TRIN have fallen further than the S&P 500 (SPY).
We believe the current pullback provides a good buying opportunity for investors looking to get into publicly traded high yield debt securities.
Before we discuss HTGC and TRIN specifically, let’s try to get a better understanding of how venture capital works and what exactly venture capital is. debt is.
What is venture debt?
Venture debt refers to specialized loans for start-up companies that are backed by venture capital and are not yet profitable. These are companies that have proven the viability of their product or service or business model but do not yet have positive cash flow. They still burn money.
This is why interest rates for venture capital debt are high – that is, high single-digit rates or low double-digit rates. Growth-stage start-ups constantly need to raise more capital, not only to fund business operations, but also to pay for previously raised capital funding costs. If capital markets deteriorate on these start-ups and their fundraising abilities are compromised, they will eventually run out of cash and be unable to repay their debts.
In some ways, venture debt is the opposite of venture capital investing. Venture capitalists invest in a wide range of startups knowing full well that most will either fail or just do well enough to break even. It’s those precious few high performers that become huge success stories where the vast majority of venture capitalists’ profits are made.
Venture capital debt investors, on the other hand, provide short-term loans that typically last 2-3 years, in the expectation that most borrowers will be able to meet the full payments. contractual interest and costs, and to repay the principal in full. Only a minority of loans will default and will need to be settled one way or another.
However, many venture capitalists also participate in the growth potential of their start-up companies through small stakes or warrants. As far as venture capitalists are concerned, many of these holdings never generate a return, but a portion of them do. And a handful of those who produce a return are huge winners.
The vast majority of venture capital takes the form of equity investments. The venture capital debt market is only about 10-20% of the size of the venture capital market. Historically, lenders have not made a habit of lending to businesses in cash burn mode. But the appetite for high-growth companies in public markets and among large, cash-rich companies has made debt more attractive to founders than equity dilution.
For most early-stage companies backed by venture capital, the terminal liquidity event for much of the capital raised during its growth phase is either being bought out by another company or to be listed on the stock exchange. Stocks sold to a buyer or in public markets provide a return to venture capitalists.
That said, let’s look at two high-yield BDCs that focus on venture debt investments.
1. Hercules Capital
HTGC is a leading provider of venture capital loans to high-tech companies, primarily in four key sectors: technology, life sciences (biotech), software and green energy/sustainable technologies.
HTGC has a debt portfolio of approximately $2.4 billion, as well as warrants in 103 of its corporate borrowers and equity investments in 76 of its companies. These early growth stage companies include many of the country’s most promising brands and innovative technology developers.
Critically, around 95% of HTGC’s debt portfolio has floating rates, giving it substantial profits if the prime rate rises further from here. Considering how serious the Federal Reserve currently seems about raising its key interest rate, this should give HTGC a significant advantage in the coming years.
Additionally, HTGC enjoys a strong balance sheet, a modest 100% debt-to-equity ratio and an investment-grade credit rating of BBB+, which helps the company keep its own borrowing costs down. a low level.
In the first quarter of 2022, the net asset value per share of HTGC suffered a decline of 3.6%, from $11.22 at the end of 2021 to $10.82 at the end of March 2022. This is mainly due to by the fact that the value of HTGC’s holdings fell along with the entire stock market and in particular the Nasdaq index (QQQ) and ARK Innovation ETF (ARKK):
Now trading at a price to NAV of approximately 1.35x, HTGC is priced slightly below its historical median premium to NAV of 1.4x, based on a historical range. from 1.1x to 1.7x. But if BDC’s NAV per share rebounds just back to the $11.22 level where it ended 2021, HTGC’s price to NAV would fall to 1.3x.
2. Trinity Capital
TRIN practically shares the same business model as HTGC. BDC provides debt capital to growth-stage high-tech companies backed by venture capital in a variety of fields. TRIN holds a portfolio of 79 debt securities worth $865 million as well as mandate positions in 70 companies and interests in 22 equity interests.
In contrast to HTGC’s strong tilt towards biotech, software and internet companies, TRIN’s portfolio features greater diversification across business models, but with a similar focus on innovation.
TRIN seems to take a little more risk on its borrowers than HTGC, at least judging by TRIN’s 12.9% base debt yield compared to HTGC’s 11.1% base yield.
On the other hand, TRIN also has a lower percentage of floating rate loans in its debt portfolio (~60%) than HTGC, which gives it a slightly lower advantage on rising interest rates. It should be noted, however, that TRIN has been steadily increasing its portfolio share of floating rate loans.
TRIN’s track record is also strong, but not quite on the same caliber as HTGC. Compared to HTGC’s BBB+ credit rating, TRIN’s credit rating is BBB. Compared to HTGC’s debt-to-equity of 100%, TRIN’s debt-to-equity is 120%.
That said, TRIN is also cheaper and more capable than HTGC. With NAV per share ending Q1 at $15.15, TRIN is currently trading at a price to NAV of approximately 1.1x.
Moreover, TRIN covers its quarterly dividend quite comfortably. In the first quarter, net investment income per share of $0.57 covered the dividend of $0.40 at 143% coverage.
For investors looking for high returns from rising interest rates, BDCs are generally a great option. And it’s also fun to be part of the growth of the most innovative venture capital-backed growth companies in the country.
For those comfortable with the particular set of risks that come with extending debt capital to primarily cash flow negative (but established and fast growing) businesses, HTGC and TRIN are excellent options. high income opportunities to consider.