Question

Venture Debt Exercise Calculate the effective rate among the three potential lenders using an Excel file. Be prepared to discuss the pros and cons of each term sheet

Lender #1 Lender #2 Lender #3
Commitment $2,000,000 $2,000,000 $2,000,000
Interest only period 6 months 12 months none
Amortization period 42 months 36 months 48 months
Prepayment penalty 3-2-1 none $20,000
Interest rate Prime + 2% Prime + 1.75% LIBOR + 1%
Warrant coverage 10% 12% 5%
Loan Fees $10,000 $15,000 $12,000
Warrant strike price Last round Next round Last round
Warrant stock Preferred Preferred Common
Last round price $1.00 $1.00 $0.10
Expected next round price $2.00 $2.00 $0.40
Expect the warrants to be exercised at 3x the strike price at month 60

Answer 1

The student's task is to calculate the effective interest rates for three potential lenders in a venture debt scenario, considering loan fees, prepayment penalties, interest periods, and warrant coverage among other terms. This financial exercise is crucial for understanding the different costs associated with borrowing from various lenders and the impact of those costs over time.

Step-by-step explanation:

The student's question involves calculating the effective interest rate and analyzing various terms provided by three potential lenders for a venture debt scenario using an Excel file. This type of exercise is common in finance and business studies, focusing on the understanding of loan terms, costs associated with borrowing, and valuation of related financial instruments like warrants.

For each lender, the effective interest rate can be calculated by considering all loan terms such as the interest only period, amortization period, prepayment penalties, loan fees, and the cost of additional components like warrant coverage. These factors can be complex and their impact on the cost of the loan varies. For example, Lender #1 has an interest rate of Prime + 2%, a 6-month interest-only period, and a declining prepayment penalty structure. Lender #2 has the lowest interest rate of Prime + 1.75%, a longer interest-only period, and no prepayment penalty but the highest warrant coverage, which could be costly if the company's stock price appreciates significantly. Finally, Lender #3 provides an interest rate of LIBOR + 1% without an interest-only period, charges a flat prepayment penalty, and the lowest warrant coverage, which can be desirable.

It is important to consider the time value of money when evaluating these options. Calculating the expected value of warrants and their impact on the overall loan cost would require assumptions about the company's performance and market conditions.