BayStar launches $1B lending fund

BayStar Capital, a venture lending firm for post-IPO companies, is raising $1 billion for BayStar III, PE Week has learned.

The Larkspur, Calif.-based firm, founded by Managing Partner Larry Goldfarb and which employs 13, has already raised about 30% of its target. It expects to close the fund by the end of the year, sources say. BayStar III will be substantially larger than its $250 million second fund, raised in 2002.

Fund III will not veer from the firm’s focus. The fund will lend $15 million to $25 million to small-cap technology companies to fund development, acquisitions, or any specific project that will quickly improve the bottom line. BayStar offers debt that can be converted to stock, allowing the firm to reap venture-style returns if the company it has invested in does well. The fund will not lend for general corporate purposes.

BayStar invests primarily in public companies, which the firm says fills a niche left open by regional and expert bank consolidation and a lack of analyst coverage in small-cap stocks. Large banks often have a tough time justifying the resources to make the type of small loans that many newly public companies need, say sources familiar with BayStar’s plan.

While equity investors are subject to valuation swings, BayStar sees much less down-side risk. If a stock tanks, the company can still collect its debt. If the stock does well, it can convert the debt into stock and sell its position.

Among the investments from fund II was SCO Group (Nasdaq: SCOX). BayStar entered into conflict with the Lindon, Utah-based company two years ago over the firm’s attempt to sell its position in the company, which offers Unix products and services. BayStar invested $20 million in convertible debt in 2003, alongside The Royal Bank of Canada, which invested $30 million. The money went to help fund SCO’s legal battles against companies using Linux, which SCO claimed violated its Unix copyrights. BayStar had hoped SCO would discontinue its Unix sales and focus on its litigation, but decided to pull out its investment within six months. The stock plummeted during the pullout process and had still not recovered. SCO stock was trading for about $2.40 a share last week.

The efforts to raise a $1 billion fund comes during a resurgence of venture lending. Former Comdisco CEO Jim Labe launched TriplePoint Capital and its $310 million venture lending and leasing fund at the beginning of the year. And hedge fund Ritchie Capital started a $200 million lending fund in September.

Lenders aren’t the only ones that have been working the small-cap technology market. Traditionally early stage venture investors are also becoming increasingly involved in post-public growth financing. Sequoia Capital, for example, worked with Francisco Partners to put together a $42 million investment for Blue Coat Systems (Nasdaq: BCSI), a $200 million public company, in June. The investment funded Blue Coat’s acquisition of the NetCache business from Network Appliance. Blue Coat picked up 1,000 blue chip customers from Network Appliance and technology to help it accelerate streaming media.