Solution Providers Leverage VC Firms As New Financing Source

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There's a new player in town for channel financing.

Actually, several new players, thanks to a variety of venture capital and private equity firms eyeing investments in fast-growing cloud and managed services businesses. As a result, some solution providers are turning to this new source of financing to help fuel their growth.

Compared with the past couple of years, VC and private equity firms are showing increased interest in the channel, said Edison Peres, senior vice president, worldwide channels at Cisco Systems, during a roundtable discussion of channel chiefs with CRN editors earlier this month.

[Related: Channel Financing Week]

"What's interesting is that a lot of the venture capital players are now investing in the channel who never had an investment in the channel before," Peres said. "So this new money is coming in through these new venture capital guys who now see an opportunity in our world that eight years ago they didn't see. They see market transitions as an opportunity to make a play, and there are a number of market transitions happening right now."

Why are VC and private equity firms so interested in solution providers? Arguably the biggest factor is the move to recurring revenue streams around managed and cloud services; by virtue of their financially stability and cloud allure, these companies have become much more attractive destinations for venture capitalists.

"They believe in the transformation in the cloud services space and they share the belief of growth potential," said Grant Kirkwood, CEO of Unitas Global, a private cloud and IT outsourcing solutions firm that recently scored a big round of VC funding.

But how does VC funding differ from other types of financing for solution providers? Generally, collateral is mandatory in order to receive loans from a bank. However, many solution providers that focus on IT services don't have the hard assets to provide a bank, said Ron Edinger, CEO of VC firm Liquid Capital.

"Post-2009, banks were very oriented toward loaning against hard-asset collateral, and our model is meant to overcome that part of a bank," said Edinger. "While an invoice is a form of collateral, it's a different kind that bothers banks. [When VARs] want a higher growth model or bigger contract, their bank won't automatically increase their credit lines with the amount of the contracts they have."

With firms such as Liquid Capital, solution providers are able to have their working capital extended. Unlike banks, VC firms look at the assets of an IT company such as people, said Edinger.

"We take a very different view and have ways of collateralizing an invoice or contract," said Edinger. "They have to manage the cash flow and that depends on their customers paying them on time, so what we provide is a way of making sure [companies] always have the money to meet payroll to maintain their biggest assets, and their people."

Cloud and managed services provider ADAR IT secured a $2.4 million funding deal with Chicago-based VC firm MK Capital in February 2014. The investment will go toward expanding ADAR IT's sales team, marketing and geographical expansion, said Vadim Vladimirskiy, CEO of ADAR IT.

"We were cash-flow-positive already; we didn't need to bridge the gap but wanted to make sure this investment was a very strategic one with a growth projection in place," said Vladimirskiy. "The reason to go with a VC firm was for the strategic alliance as they have experience in the channel and their track record is attractive."

According to Vladimirskiy, VC firms aren't looking at assets from VARs because they are essentially becoming an equity partner.

"They are taking the same risk the founders are," said Vladimirskiy. "They are not lending the money to the venture; what they are looking for is a business model that has a lot of off-site potential in scaling and being successful when they [become] large."

VC firms can forecast the potential success of a company by looking at different metrics besides balance sheets, said Vladimirskiy. Such metrics include customer retention.

"How [well] they can retain customers is an indication that they're doing something well and will be continuing that when they grow," said Vladimirskiy. "In our case, MK [Capital] saw that our retention was very good and it's the culture that we built from day one where we always focus on our services to help our clients get their work done."

NEXT: The Investment Lure Of Services

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