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MDV playing crucial debt venture role in ecosystem

-Digital News Asia (DNA)

VENTURE debt is not as sexy as venture funding but it is equally important and will likely keep you afloat when you get your first big contract – ‘big’ here being relative to the size of your company.

“We have helped a lot of companies and just last year gave RM800 million (US$259 million) in loans,” says Zubir Ansori Yahaya (pic), managing director and chief executive officer of Malaysia Debt Ventures Bhd (MDV) since 2005.

MDV itself was established in August, 2002 to play the role of being a debt financier.

In the United States, where it is called venture debt, the concept is very popular with around 40% of early stage financing done in this manner.

“And mind you, their interest rates are between 16% and 20% versus our 6% and 8% returns,” Zubir says.

Those low interest loans have helped close to 500 companies over MDV’s lifespan and around 250 companies in the portfolio at present.

And, yes, you read that right above: MDV gave out RM800 million in loans last year, yet Zubir expects half to be repaid this year.

This brings to attention some characteristics of an MDV loan. “These are ICT loans and they tend to be very short, sometimes up to six months with the most at between one and two years, while the longer term loans tend to be between three and five years,” says Zubir.

Hence the expectations that around RM400 million will be repaid this year.

The quick turnover in loans repaid also means that MDV has to work harder than most banks in looking for companies to give loans to. Most of its loans are in small amounts of RM5 million (US$1.6 million) and below, to its current portfolio of around 250 companies.

It does larger amounts too, which Zubir defines as RM35 million (US$11 million) and above. “We have between six and 10 companies in this category.”

Surprisingly, despite the number of companies MDV has helped over its lifespan, Zubir shares that the concept of debt venture is still not as well known.

It may be instructive to take a step back to understand how MDV was formed in 2002.

At that time, technology companies, especially Multimedia Super Corridor (MSC Malaysia) companies, were having a hard time getting a bridging loan from commercial banks to help them fulfil projects which necessitated upfront investments.

Not many companies had the cash flow or liquidity to wait for project payments to come in, but banks would not take their projects as collateral, leaving technology companies facing an ironic cash crunch whenever they got a sizeable job to fulfil.

This is when the Multimedia Development Corporation (MDeC) and in particular, MDeC executive Jiro Suzuki, started lobbying and educating the Malaysian Government about this critical gap in the nascent funding ecosystem. [MDeC is Malaysia’s national ICT custodian and manages MSC Malaysia.]

Thanks to a RM1.6 billion (US$519 million) loan from the Japanese Government, through the Japan Bank for International Cooperation (JBIC), MDV was born. It was Asia’s first ever scheme for project debt financing. Suzuki became MDV’s first chief executive officer. Subsequently, in 2007, the Ministry of FInance approved RM2.5 billion for MDV’s Second Fund.

‘Sort of hybrid between bank and VC’

Zubir notes that most people cannot differentiate between venture debts and loans given out by banks.

“To put is concisely, the biggest difference is that commercial banks lend on the strength of the company; we lend on the projects received,” he says.

“Because of this, our biggest collateral are the projects they have, and hence we need to make sure that the proceeds of the project come to our account first, where we take our portion before releasing the balance to the company,” he adds.

In the early years, there was criticism that MDV took too long to release the money due to companies, but it has since rectified this.

Unlike banks and like VCs (venture capitalists), MDV also puts an officer on board of some of the companies, especially those it has given loans for RM35 million and above. “We don’t have a board seat but just sit in as observers,” says Zubir.

This was the case with Packet One Networks (P1) which received a loan of over RM50 million (US$16.2 billion). “They are a very well-managed company, and have paid back almost all the amount,” he adds.

Some of the companies MDV gives loans to are very small, and he notes that MDV’s presence helps these companies a lot.

Aside from loans, MDV offers advice and nurturing services too, which is why Zubir says, “We are a sort of hybrid between banks and VCs.”

A look through the profile of MDV’s senior management team reveals a seasoned team with deep multi-industry exposure.

Convertible option a valuable instrument

Meanwhile, that line between VC and venture debt is blurring a little as MDV also will put in an option where its loan can be converted to equity, but at the point where an M&A (Merger & Acquisition) is happening.

Even here it draws the line to actually taking equity.

“Through our involvement with these companies over the years, we have come to realise that many companies tend to go through the various cycles of validating their idea, getting funding, conducting their R&D, getting a product ready and then, they need funds to go to market,” Zubir says.

“We think this stage of commercialisation is where the biggest funding gap exists in Malaysia,” he adds.

MDV went to the Government in 2010 and got a RM40 million (US$13 million) loan for this purpose. Calling it a commercialisation fund, MDV selectively loans money to companies with a RM5-million cap per company.

What’s unique here is that the loan is given without the prerequisite of a contract in hand. “As an example, we think cloud computing is an interesting value proposition although the market take-up is very slow,” says Zubir.

“Still, we think there is a business case and gave three local cloud computing companies loans of between RM3.5 million to RM5 million each,” he adds.

MDV sees this commercialisation fund as a very valuable proposition as it allows it to fund and grow companies that are at the pre-commercialisation level.

“The idea is that if they succeed, they will continue to take loans from us,” says Zubir, adding that some companies have taken as many as 10 loans from MDV.

In most cases, the interest rates are marginally higher than the usual contract backed financing “but still below 9% and lower than rates offered by banks for high risk companies with uncertain project success,” he points out.

MDV could not have given any money to these types of companies under its existing fund which is tied to contracts. Furthermore, since MDV considers the projects high risk in nature, in most cases under this RM40 million fund there would be a convertible option attached to the loans so that a conversion can be done at any point of an M&A.

Explaining how this works, Zubir says that the loan is converted only at the point of an M&A because this is when a company is being valued.

“If the valuation is favourable, we take up the option and put a call option immediately so that owners or buyers take up our portion of the convertibles immediately, and we cash out at that point. This means we do not need to hold on to any shares and eliminate the risk of uncertainty,” explains Zubir.

A minimum 15% conversion rate will trigger MDV to exercise its option to convert its loan. In other words, if the M&A values MDV’s loans to a company at a 15% premium, it will exercise its convertible option.

This convertible option is not just limited to the RM40-million commercialisation fund. MDV will put in this option of a loan with a convertible option for any company it thinks has an opportunity to go for an IPO (initial public offering) or be engaged in an M&A.

Some education still needs to be done here though, as some entrepreneurs are wary of this debt convertible option.

“But when we explain to them how carrying a debt on their books will affect their valuation during M&A, they tend to understand,” says Zubir, who describes it as “I see a light bulb go off.”

The real light bulb went off more than 10 years ago however when MDeC and its executive, Suzuki, saw the need for a debt financing vehicle, and acted on it.

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