Episode 53: Randy Garg of Vistara Growth on
Leveraging Growth Debt as an Alternative Means of Funding 

Episode Transcript  

 Shiv: Alright Randy, welcome to show. How's it going?

Randy: It's going great, thanks for having me.

Shiv: Yeah, excited to have you on. So why don't we start with your background and about Vistara and then we'll take it from there.

Randy: Yeah, so I've been at this tech investing game for over 30 years now. So a bit of a dinosaur when it comes to that, I guess. But I started investing in tech companies back in the early 90s as a VC. So investing in early stage companies here in BC. Worked with a number of ones that went on to become very successful companies. And then sort of, I'd say, mid-2000s after the dot-com bust and everything else, I moved more to growth stage companies, initially on the sell side, but then my passion has always been on the buy side. So investing in these companies and helping them through their growth journeys. So back in 2010, I launched a family office fund with a close contact of mine to invest in growth stage technology companies using a strategy that we'll talk about here, more flexible, former growth capital that we continue to do to this day. And in 2015, nine years ago, spun off and created Vistara following the same strategy. So we're nine years later, we're five funds in and continuing to do what we do.

Shiv: That's great. And talk a little bit more about that side of it. Because yeah, you mentioned before we even started this episode that one of the things that differentiates you guys is your flexibility and all the different types of funding options available. So what are some of those vehicles that you're leveraging and how does that distinguish you?

Randy: Yes, I guess having gone through the VC journey and working with companies at different stages in their evolution, they're rarely if ever is just the absolute right form of capital, obvious form of capital at different times. So, you know, we've taken the approach where there's times where debt makes sense, there's times where equity makes sense. So to come at it from a more flexible standpoint, we think fills a gap in the market. And really what we do is we fill the gap that exists between traditional sources of debt capital for tech companies and traditional sources of equity capital. So if you think of traditional sources on the debt side, one would normally think about banks as a traditional source of debt capital there. And then on the equity side, you've got venture capital at whatever stage it might be or growth equity or increasingly private equity. But in the middle, depending on where the company's at, and what its objectives are, it may make sense to do some form of a hybrid type instrument, which is something that we've done consistently across our funds.

Shiv: Can you give some examples of that and when does it make more sense to go with let's say the growth debt route versus the growth equity route?

Randy: Yeah, so most, if not all, of our deals start as debt. So we look at that as a way to get into the company, get to know the company, understand the profile, figure out ways that we can continue to work with them. We've often done convertible debt, where we will look to convert into the next equity round. There's been a couple of examples where we've created the equity instrument that others wanted to come into using our convertible debt. That's been particularly helpful with a couple of our companies, Zafin and Core.ai, where we had strategic partners, customers wanting to invest into the company. But typically those types of entities don't tend to lead or price deals. They would tack onto deals. But we were able to create the instrument as, at that point, an equity holder that they were able to come into. So really acting as a catalyst to helping some of these equity rounds come together.

Shiv: And why not go the equity route? I intuitively obviously understand why and we work with a lot of equity investors, but, and debt has benefits too, but just help us understand that because you're giving up the upside in a lot of cases, especially when you're investing in tech companies. But then on the debt side, I guess it's more of a reliable return, but just help us understand what your thinking is there.

Randy: Yeah, so we've raised our funds from LPs that view us as a credit first fund. So we have three core tenants. One is security, next is yield, and the third is upside. So because we invest in tech and we're not investing in mortgages or infrastructure or whatever, it's not just about covering downside and yield. We do want to participate in the upside. So typically that's in the form of warrants or in the form of a convertible where we can look at seeing the upside eventually becoming an equity holder in the company. But we rarely, if ever, go in straight off as equity holders. We usually use debt. And we've done that across our funds. And that's enabled us to raise the $800 million that we've raised across our five funds and deliver the kind of returns that we've returned to our shareholders.

Shiv: Right, and when you look at the type of returns you're aiming to generate, it would look different than a firm that's deploying it as more into equity investments, right? So talk about hurdle rates or just target rates that you're trying to, or returns that you're trying to generate for your LPs.

Randy: Yeah, so we're targeting returns in the teens at the end of the day on a net basis. And that's formed through income, that's formed through capital gains on the warrants or the converts. But I think one thing that's different between our funds and typical venture funds, actually there's a few differences, but one thing is that all of our deals perform. We've done 39 deals, we've had 20 exits, we've never lost a penny on a single deal. So it's not the venture model where you need two or three massive home runs to carry the fund, and then you're going to have a whole bunch of losses as part of it. So we have all of our deals perform, deliver that kind of mid-teens return, and then within that, we have a few where maybe the upside is particularly high, and that boosts the returns even higher. So we've seen that in a few of our funds. But it's a very different model from that standpoint, and also the duration of the funds is very different.

Shiv: How does the duration change?

Randy: Yes, so typical VC funds are 10, 12 year or even longer type funds, whereas our funds are more in the six to eight year variety. That's a function of the types of investments that we do. But also we tend to get involved with companies that are a bit further along in their lifecycle. So this isn't targeted towards startups. Our companies tend to be Series B and beyond if they're venture backed. They're doing anywhere from 10 to 100 million of ARR, typically 20 million plus of ARR. So the path to eventual exit for us is truncated.

Shiv: Yeah, I was going to ask that was going to be my next question on selection is because you mentioned that all deals perform well, usually that only happens in cases where the companies are more established, right? So talk about the selection criteria or what you need to see before you deploy capital.

Randy: Yeah, we're pretty strict on our criteria. Security yield upside is what we look for. So first and foremost, don't lose principle. So we're targeting companies that are, as I said, on average doing 20 million or so of ARR, at least 10 million of ARR. These are high gross margin businesses. They're not necessarily profitable. Most of them aren't profitable when they come to us. But there needs to be a clear path to profitability through the three, four, five years that we're looking to commit to these companies. Our model is also not reliant on the next round of venture capital coming in. So that's what we call venture debt. So we very clearly differentiate ourselves from venture debt. We call ourselves growth debt because we don't necessarily need the next round of VC to come in to fund the burn rate of these companies. We want to ensure that the business plan is funded so they can go. So it's a combination of these factors that really drives our underwriting. Then it's the quality of the end markets they're selling to, customer concentration. We're only B2B, we don't do consumer. We also saw a bit of a trap that a lot of investors got into where they were investing in tech companies that were selling to other tech companies. A down draft happens, nobody's got money to spend on each other's software. We don't do that. We invest in companies to sell the banks, government, health care, the like. So we've done that since the beginning. We did that in the family office I was running and since the beginning of Vistara. I'd say the other part of it is really we take an active role with these companies. We're observers on the board. We have monthly reporting. So it's very rare that we never get surprised on something. So as a result, we're able to know, help these companies be proactive about doing things that avoid some of the downside scenarios that you see from time to time. 

Shiv: With these kinds of companies, like, you know, the competition is super high for premium assets, even as the market has slowed down over the last couple of years. So talk about why you're still winning deals or able to distinguish yourself and how much of that has to do with this idea that, you know, debt is in a way, I don't want to say lower risk, but it's like you're taking on, you're not necessarily taking on adding more people to your equity stack. And that changes kind of how you perceive companies as firms as a partner. Is that is that the reason or is it something else?

Randy: Yes, let me try to address that on the company side, we tend not to chase the super high flying, sexy deals. They tend to come with really big burn rates as well, so we're not into that. Those are equity deals and equity will chase those deals and pay huge multiples on them. So we're less likely to go into those. For us, our types of companies tend to be more of the, they might be growing 20, 30, 40 percent and maybe burning a little bit of money. So in fact, they may not have that equity profile. So the equity folks tend to look for these 3X, 5X plus returns. The companies may just not have that profile. So in their case, they still look for growth capital, whether it's for organic growth or more and more these days for tuck-in acquisitions, for some other smaller competitors that can't get funded. Our type of capital really plays an interesting role there because we can do it without having to price the equity, without having to dilute. It tends to be a lot more than what they can get from a bank who would tend to want to see these acquisitions in the rear view mirror, consolidated results, all of that. Whereas we can look at these on a pro forma basis and see how it makes sense for these companies. So again, it's really filling that gap, but it's not chasing the high flyers. It's really after the companies that are sensible about capital. And one of the best things that's happened in the past couple of years is companies have gotten sensible. They don't assume that the next round is going to come at 2x evaluation 18 months ago. They are a lot more sensible about their burn rates and what their game plan is on capital raising.

Shiv: Right. And in a situation like this, and that's a great answer. That's helpful. guess, even if I'm like, cause a lot of mid-market private equity firms will say they're going after 10 to $50 million ARR businesses that have positive EBITDA or are, meet the rule of 40. So they're healthy businesses. have good net retention. Like a lot of these things are consistent or similar across private equity firms. So I think my question is more in those instances where you kind of have competition from folks that will want to either buy out the firm or take a minority stake in the equity side and versus on the debt side, but to fund similar ideas, right? Cause you still want to do M&A, you still want to fund product development or accelerate your go to market or expand your sales team. So when, if a founder or an operator is thinking about those two options, like why go with this model outside of just dilution or avoiding dilution?

Randy: Yeah, we work with a lot of growth equity firms. They target a lot of our companies because we do play in that same area as you mentioned. But in many cases, if it's a minority growth equity firm, we're there alongside them providing some debt, maybe even investing a slug of equity alongside them. It just creates a better dynamic for the company. And then when you're looking at future acquisitions, yes, they could be putting additional equity capital to work in those deals. But quite often they're looking at debt. They're trying to enhance their own return on equity as they look at what they've invested in. So it tends to be very complimentary. It's way less competitive than you might think. And that goes for VCs as well. In most cases, the VCs view us as a way to extend runway for their existing companies. Maybe it's not the greatest time to raise VC money, as we've seen in the last little while. Companies aren't getting the valuations they used to. But they need that extra slug of capital to get them up to cash flow positive. So that's a great use for our style of capital. So we'll get deal flow from banks that are looking for ways to provide more capital to their customers. We'll get deal flow from VCs, from Growth Equity, investment banks, kind of all over. We're sort of Switzerland in the middle of all this.

Shiv: Yeah. Right. And I want to come back to something you mentioned earlier in terms of your underwriting process, right? Because in a way, when as you're issuing these instruments, you're, you are building like a value creation plan. So you're looking at thing or avenues or levers available to the business that can actually grow it further. So how actively involved are you there? Or are you more just understanding what the management team or the company wants to do? And then giving them the debt facility or what have you and then leaving them to their own devices or are you actively playing a role in the value creation part of the business?

Randy: Yeah, I would say for us it's very much being a supportive partner in the value creation process. We bring a lot of experience, knowledge, contacts, things that we can provide to companies, but we're not getting into these companies with a playbook or with telling them how to run their business or whatnot. We add value where we can. We've been asked to help with finding board members, finding executives, customer introductions. We have our own advisory board of former current or former CEOs of tech companies that we make available if needed to any of our portfolio companies. So we try to help and plug in where we can. We're not coming in and telling them how to run the business. We're a lender for the most part at the end of the day, so we can't. If we're telling them how to run the business, that means we're probably running the business. And we haven't had to do that yet across close to 40 companies now. We want to continue to do that. And these are more mature companies too. These are companies that are doing usually 20 plus million of ARR. They've built out their management teams. They've got some scale. Usually the founder, it's not their first rodeo. They've done it before, but they need our help. They need our capital for sure, but then they might need our help on M&A, on financing, on whatever the topic may be.

Shiv: Right. And I guess does that aspect of lesser control in an investment or a customer, if you will, does that, how do you try to influence in situations where you're seeing like, yeah, we underwrote something, but there's clearly certain levers available or certain avenues available for growth that the company may not be capitalizing on. Like, are you trying to even influence in situations like that, or are you just staying out of operations even then?

Randy: Yeah, again, I think it's really about knowing your role. So as a lender, we have covenants. So we'll have covenants around the business not shrinking or on a four-year, five-year deal by say year three, they need to become profitable. So if they're clearly going down a different path, that's going to take them further and further away from that. We'll have the discussion with them. And if it's really you're going down a different path, that maybe this isn't what we signed up for. So let's find a way to get us refinanced or whatever the case might be, or amend the covenants, bring in some equity, whatever need be. We try to be as collaborative as we can. We've introduced our companies to equity partners that we've worked with over the years. So it's really a collaborative exercise and it's being that growth partner, but we're not gonna necessarily tell them what to do, if you know what I mean, because part of it is, you tell them to really go for it and they break your covenant and they come back to us and say, you told us to go for it. Now why are you criticizing us for breaking your covenant? So you got to, I guess at the end of the day, you got to know your role.

Shiv: Right. Yeah, and the concept of covenants is interesting, right? Because a lot of things that we preach to companies for what it's worth, like, know, we're working with these PE firms on the marketing side and we're often teaching companies to think about their marketing strategy within the financial constraints of the business. And so I guess an interesting question here would be is how much are those covenants or what kinds of covenants are you using to like hold a company at least accountable or at least have regular check-ins and what are some of those metrics that you're having those conversations around?

Randy: Yeah, it's pretty basic. It's nothing that you would find or companies would find overly onerous. It tends to be something around revenue profile, essentially don't shrink would be the main one. It's around liquidity. Don't run out of money. So sort of have three, six, nine months of cash on hand at all times. And then as I mentioned, we tend to get involved with our companies for more like three to five years as opposed to short term ridge type situations. So at some point, a couple of years within the term, we want them to get to cash flow positive. We understand that they're taking our capital for a reason and the reason is to grow. So they're probably going to continue to burn during that period, which is fine. That's what we signed up for. But at some point they need to become profitable. And that's really it. The rest of it's around reporting and normal stuff that these companies are used to anyway. I think it's really about don't shrink, don't run out of money and eventually start making some money.

Shiv: Yeah, those seem to be fairly standard. As you look at companies in the marketplace today, do you think more should be considering debt as an instrument to kind of ride out some of these times? There's a of companies that have shrunk their revenue profile or may not be growing as fast as they expected, may not be as profitable as they expected. And so where do you see debt playing a role in that type of a marketplace?

Randy: Yeah, we've seen a tremendous increase in not only the demand, but just awareness of debt as a solution. Private credit overall as a category is one of the fastest growing categories in private capital, but traditionally focused on traditional industries. So private credit within the tech industry is not as well understood. But it's a very, very big business with a lot of well-known players that are playing in it. So think most CFOs, most CEOs, boards, investors realize that debt can be a useful ally. Where things went a little bit sideways was during the whole SVB crisis. So for lot of these companies, they viewed debt only as what they were going to get from their bank. Post SVB, a lot of the banks sort of retreated in terms of how much capital they're willing to provide to these companies. And also the VC's retreated. So that gap that we filled got a whole lot wider. Over my career, over 30 plus years, I've often, not often, I've always seen banks as working capital and not necessarily growth capital. So for growth capital, you should be raising equity or more creative forms of debt or convertible debt that can provide that growth capital, longer term growth capital. So I think that's where the understanding is coming to bear here and that's where we're seeing the opportunity.

Shiv: Do you see companies that raised at the significantly higher multiples in 2020, 2021 that are almost using debt as a facility to catch up to their like whatever their valuation is on the books?

Randy: For sure. And if they catch up or not, who knows, but at least it avoids them having to go to market to price their equity. We've seen a bunch of very ugly equity term sheets out there, but that's the market. When the company is raised at a super high valuation, hasn't really caught up to that, you're probably facing some pretty onerous terms in terms of multiple liquidation preferences and whatnot, or pay to play type rounds. So we've seen that. But even outside of that, before going down that route, I think a lot of companies understand that there are other options, like debt, that they can look at using. They've also cut their burn rates. A lot of these companies have gotten very sensible over the past couple of years. So they don't necessarily need that massive equity round now to continue to fund the company. They need a more modest amount of capital, which is, think, where our type of solution plays really well.

Shiv: Yeah, it's almost like the lack of capital force companies to focus on profitability more, right? So yeah, and then that makes them almost more attractive for investment or even taking on more debt.

Randy: And the really fast growing, 100% plus growing companies will always continue to attract equity. And then from time to time, you'll have hot sectors like AI and whatnot that'll get a lot of interest and attract a ton of equity. But the sort of messy middle, the companies that are growing at 10%, 20% and modestly profitable, I don't see them necessarily attracting equity other than being consolidation candidates. We're seeing a lot of that too, where these companies are all getting gobbled up by PE firms on their various platforms.

Shiv: How do you bridge that with this need that equity funds, they need to realize their funds over a certain term, right? Like their LPs expect a return and at the same time, like the valuations haven't caught up to what they are on paper. And so where does debt play a role in that to provide liquidity to some of these LPs?

Randy: Yes, it's so our type of debt is being invested directly in companies not leveraging funds. There are other credit providers out there that are basically recapitalizing funds. So doing NAV loans and that type of thing. So creating distributions for these venture funds to their LPs so they can actually go and raise their next fund. It's a tough market because nobody it's really hard to understand the marks. on some of these holdings. But if you've got a very solid portfolio and well-recognized companies and you can very clearly see the marks, that is certainly an option. There's an active secondary market as well for these firms. But I think to your point, it's just taking longer and longer for these companies to exit the funds, to exit their positions. There's not really much of an IPO market. It's a very discerning M&A market on the strategic side. The big PE funds are certainly buying up lots of companies, but they're not buying the heavy burn rate companies. They're buying ones that fit more of a PE style profile. you again, it depends. Most of the venture, venture stage companies are still in that burn mode by and large. So it's really, it'll be interesting to see how it plays out. I think you've already seen some attrition in the VC fund market. Many funds just aren't able to raise their next fund because they haven't delivered the returns to their LPs.

Shiv: Right. I guess, yeah, that's a good point is the, that you mentioned that it's, you're not funding, the debt that you're putting on the business is being invested into the business, not to give liquidity outside. And so, but at the same time, the companies need that as well, because they're trying to extend their runway or get to kind of where they need to get to. And that might be the only avenue available to them.

Randy: Yeah, very occasionally we've done some deals as long as a business plan is funded where maybe part of the funds were used to buy out some early founders or something like that. But it's not designed to be a VC liquidity type deal.

Shiv: I guess that shrinks the types of companies you can support, right? Because if there were secondaries and other areas where you can play a role that's different, like, from what I understand, growth debt is a longer timeframe. It can be as much as five years time that you're holding onto the debt, which is very different than bank debt or venture debt that you're taking on. So the specific types of companies you're looking for are ones where that type of a term to generate a return for themselves or that's kind of the horizon that they're thinking about their growth plans as well.

Randy: Yeah, we tend to sign up for sort of three to five years with these companies. Our average hold period tends to be closer to three years, frankly. So we'll exit when sometimes the companies get profitable and the bank takes us out. We'll exit when they actually do maybe raise their next equity round and we make it taken out as part of that or the company sells. So depending on when we get involved, maybe they've already got a view on when they plan on exiting in the next two, three, four years and they'll use our capital to get from here to there. But there's a lot of these coming. We were just looking at some stuff in PitchBook. There's, you know, in what we call sort of the mid later growth stage arena across North America, we invest across North America, there's 18,000 of these companies, right? And we're doing eight to 10 a year. So there's a lot to choose from.

Shiv: Yeah, a lot of companies out there at that stage. Do you see a lot of firms that provide that facilities like you or is that is that part of the market less addressed, I guess, because we you know, we meet as we meet private equity firms like we've met some smaller ones. And one of the statistical points is just that most people do not focus on smaller companies. And so that people have seen that as like a green field for them to build a, build an investment firm in terms of the type of work that you're doing with this growth that is there a of competition for what you're providing to these companies?

Randy: Yeah, so from the time I started doing this at the Family Office Fund back in 2010 and then Vistara from 2015, there's certainly been more players that have come in. But what I'd say is it also bifurcates by check size. So at the 30, 40 million plus level, you've got a lot of the big players, the big well-known players that play and have these very, very large funds. At the sub $10 million level, you have a bunch of these smaller funds. But in that 10 to 30, 10 to 40 million dollar zone, there's a certain number of players of which we are one. And then it really depends on are you differentiated within that? So do you have a one size fits all type offering? Or can you be more flexible around debt, convertible debt, structured equity? I'd say the other thing that differentiates us from others is in the middle you have this category called venture debt, which really is your underwriting is largely based on the sponsor and how strong the sponsor is, because you assume the sponsor is going to be there to continue to support the company. Our underwriting is more focused on the company and whether they can support themselves if the sponsor isn't part of the equation anymore for whatever reason. So there's different ways and different approaches to the middle part of the market that we cover off, check size being one of them, but also approach being another big element.

Shiv: Totally, yeah, I think that's great insight and I think that would be a good place to end the episode. But before we do, if people want to learn more about what you do and your firm, where should they go to find out?

Randy: Obviously, our website, VistaraGrowth .com. There's been a few podcasts and a few other things out there. yeah, really, it's, you know, our capital comes from family offices, foundations, tech entrepreneurs. It's less institutional oriented. Our funds are getting bigger now. So we're starting to attract some interest in institutions. So on the company side, yeah, B2B SaaS companies across North America. We target them very closely and on the investor side, a lot of it's been just through repeat help ease and word of mouth.

Shiv: Awesome, yeah, we'll be sure to include all of that in the show notes. And Randy, with that said, thanks a lot for taking the time to do this. I thought there was a lot of great information about debt as an instrument and how companies can be leveraging growth debt. So I appreciate you doing this. Thanks.

Randy: Pleasure, thanks, Shiv.