Dec 12, 2023

The Founder’s Guide to Securities-Backed Lines of Credit

Arc Team

Go-To-Market

If you’ve got a few million dollars parked in US Treasury Bills or ETFs, but don’t anticipate needing funding anytime soon, a securities-backed line of credit (SBLOC) can provide peace of mind in case something comes up. Alternatively, if your startup has a large percentage of its cash invested and an unexpected need arises, an SBLOC can be quickly spun up to satisfy the requirement. In this guide we break down SBLOCs—exploring the key features, terms, and use cases, and we answer the frequently asked questions, so you can determine if it’s right for your needs. Ready? Let’s dive in!

What a securities-backed line of credit is (and isn’t)

A securities-backed line of credit (SBLOC) is a form of financing that allows startups to borrow money using their investment portfolio as collateral. The collateral typically consists of money market funds, US Treasury Bills, and other securities held in the borrower's treasury management account. SBLOCs are commonly offered by banks and brokerage firms, that also hold the underlying investments in their custody.

The key features of a securities-backed line of credit

Collateralized by Securities: The startup pledges its investment portfolio as collateral for the line of credit. The value of the securities determines the amount of credit available.
Flexibility in Fund Usage: Startups have flexibility in how they use the funds, whether for growth, working capital, Op-Ex…etc.
Access to Liquidity: Borrowers can access additional funds without liquidating their investment holdings. For startups holding money market funds, liquidity typically isn’t an issue, but for startups holding long-dated US Treasury bills, it can be.
Risk of Margin Calls: If the value of the collateralized securities falls below a certain threshold, the lender may issue a margin call, requiring the borrower to deposit additional assets or repay part of the loan to restore the required loan-to-value ratio.

How securities-backed lines of credit work

Securities-backed lines of credit are effectively a combination of an asset-backed loan that’s structured as a line of credit. The underlying securities or investments that a startup holds are used as collateral to back the available funding, like an asset-backed loan. However, unlike an asset-backed loan which typically comes with a fixed sum of capital and a fixed repayment period, with an SBLOC the startup can draw down the available balance and repay it, and then tap the available credit again as many times as they see fit, like a regular line of credit. The benefit is they can assess more credit at a lower interest rate with an SBLOC than a traditional line of credit.

The types of securities that startups can leverage to secure a SBLOC

The types of securities accepted as collateral for a securities-backed line of credit (SBLOC) vary based on the underlying financial institution offering the line of credit. Generally, the following types of securities are commonly accepted:

Treasury Securities: U.S. Treasury Bills are the most frequently accepted collateral we see for SBLOC deals due to their low-risk nature.
Exchange Traded Funds (ETFs): Some banks accept ETFs as collateral. The eligibility of specific funds may depend on factors such as the fund's liquidity and investment strategy.
Publicly Traded Stocks: Shares of publicly traded companies are a common form of collateral, though most startups likely should not be holding these.

Common terms found in a securities-backed line of credit agreement

Loan-to-Value (LTV) Ratio: This specifies the maximum percentage of the collateral's market value that can be borrowed. Typically we see the LTV ratio capped at 50%, so a startup that has a portfolio valued at $1,000,000 could secure a line of credit up to $500,000.
Repayment Terms: Details the terms and schedule for repaying the borrowed funds. It includes information on how interest is calculated and when payments are due.
Credit Limit: Specifies the maximum amount that can be borrowed through the SBLOC and is determined based on the value and type of securities in the collateralized portfolio.
Interest Rates: Outlines the interest rates applicable to the borrowed funds. SBLOCs often have variable interest rates tied to benchmark rates, such as the prime rate.
Margin Calls: Describes the circumstances under which the lender may issue a margin call, which requires the borrower (you) to deposit additional securities or repay part of the loan.
Fees: Outlines the fees associated with the SBLOC, such as origination fees, annual fees, or transaction fees.
Use of Funds: Describes the purposes for which the borrowed funds can be used, which are typically very flexible.
Default and Remedies: Outlines the conditions under which the borrower may be considered in default and the remedies available to the lender in such cases.

How SBLOCs compare to traditional loans

Collateral Type: Traditional loans typically require personal assets, such as real estate or personal guarantees, as collateral whereas SBLOCs use investment portfolios, including ETFs, US Treasury Bills, and other securities, as collateral.
Liquidity Impact: Traditional loans may require startups to sell their assets to access funds, whereas SBLOCs typically allow for liquidity without the need to sell investment holdings.
Interest Rates: Traditional loans typically have fixed interest rates that are comparable to the variable interest rates of an SBLOC.
Use of Funds: With a traditional loan, typically the lender will specify how the funds can be used, with SBLOCs typically there are no restrictions.
Time to Funding: Traditional loans are typically funded much slower than SBLOCs because the market value of the underlying investments (collateral) can be readily determined.
Repayment Period: Generally speaking, traditional loans will have much longer repayment periods compared to SBLOCs, which are capped at 1-2 years.
Revolving Capability: Traditional loans are not revolving, so when a portion of the balance is repaid, the same credit cannot be accessed again. SBLOCs on the other hand are revolving in nature, so the same credit can be accessed over and over again as it's repaid.

Common use cases of securities-backed lines of credit for startups

Satisfying Short-Term Liquidity Needs: Often, it's easier (and more cost-effective) to draw down an SBLOC to satisfy short-term capital needs rather than unwinding a portfolio of 6 or 12-month Treasury Bills that are laddered.
Maintaining Capital Reserves: Rather than liquidating an investment portfolio to access capital, a startup can effectively leverage it to “create” short-term financing without incurring additional dilution and they can pay the balance back over time.
Lowering The Cost of Capital: Because the invested funds used as collateral generate a net positive yield for the business, they offset the cost of capital for the SBLOC compared to other forms of financing.

Key advantages of securities-backed lines of credit

Highly flexible: Startups can use the funding unlocked by an SBLOC to cover operational expenses, invest in growth opportunities, manage unexpected financial challenges, and pretty much anything else they want (within reason).
Cost-effective: Because SBLOCs are collateralized, they often come at a lower cost of capital compared to other forms of financing, especially when you consider that the underlying securities are invested in vehicles that generate yield.
Funds quickly: As mentioned a few times, because the value of the collateral being used in an SBLOC is well known, startups can quickly qualify for and pull funding from this form of financing (often under a week).
Revolving Capability: As an SBLOC is repaid, the available balance can be drawn down again and again, as many times as the startup wants.

Key disadvantages of a securities-backed line of credit

Capped sizing: Because SBLOCs are based on the size of a startup’s investments, the amount of capital a startup can access is capped.
Potentially more expensive: As mentioned earlier, SBLOCs typically come with a variable interest rate that can rise as the federal interest rate increases, which can make this form of financing more expensive than a traditional term loan.
Shorter duration: SBLOCs are intentionally short-term in nature, as such they typically must be repaid in full within 1-2 years of borrowing (even though the funding can be recycled over and over again).

Frequently asked questions about securities-backed lines of credit

What types of securities can be used as collateral for an SBLOC?

The commonly accepted securities include ETFs, US Treasury Bills, bonds, mutual funds, and publicly traded stocks.

How is the credit limit determined on an SBLOC?

The credit limit is often determined by the loan-to-value (LTV) ratio, which is the percentage of the collateral's market value that can be borrowed. Generally, we see an LTV of no more than 50%.

What happens if the value of my collateral increases? Can I request a higher credit limit?

Some financial institutions may periodically reassess and adjust credit limits based on changes in the value of the collateral.

What are the interest rates on SBLOCs?

SBLOCs often have variable interest rates tied to benchmark rates like the prime rate. Rates vary among financial institutions and are competitive with traditional loans.

Can I use funds from an SBLOC for any purpose?

Yes, SBLOCs are very flexible, startups can use funds for various purposes, including working capital, strategic hires, operating expenses, and more.

How does repayment work on an SBLOC?

Startups make monthly payments on the outstanding balance. Interest is charged only on the amount borrowed, and the repaid amounts become available for future borrowing.

What are margin calls, and how do they work with SBLOCs?

A margin call occurs if the value of the collateral falls below a certain threshold. Startups may need to deposit additional securities or repay part of the loan to maintain the required loan-to-value ratio.

How quickly can I access funds from an SBLOC?

The time to access funds can vary among financial institutions, but SBLOCs often provide relatively quick access compared to traditional loan approval processes.

Can I lose my securities if the market value declines?

In the event of a significant market decline and if the collateral's value falls below the required threshold, the lender may issue a margin call. If the call is not met, the lender may liquidate some or all of the securities to cover the debt.

Can I continue to trade securities in my collateralized portfolio with an active SBLOC?

Generally, yes. However, there may be restrictions or conditions outlined in the SBLOC agreement.

Wrap-Up - Getting approved for a securities-backed line of credit in 2024

Securities-backed lines of credit can be a great option for startups with significant reserves that are invested in US Treasury Bills or ETFs but do not want to liquidate their portfolio to access short-term funding. They are highly flexible, cost-effective, and revolving, so the credit can be drawn down, repaid, and accessed indefinitely. However, they’re short-term in nature and the sizing is based on the underlying securities that are collateralized, so it's not a replacement for permanent venture capital. If you’re interested in getting approved for a securities-backed line of credit, get in touch with us!