MDV playing crucial debt venture role in ecosystem

MDV playing crucial debt venture role in ecosystem: Page 2 of 2

By Karamjit Singh June 3, 2013

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 playing crucial debt venture role in ecosystem: Page 2 of 2
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.