When Chris Lay worked as a neuroscientist at the University of California, Irvine, he won a $2.5 million contract from the Defense Department’s advanced research projects agency, known as DARPA.
He then found banks were unwilling to lend to his startup.
“We took that contract to our business bank, and the offer to me was a $35,000 personal guarantee line of credit,” Lay told the Business Journal.
“If I had that same contract with a commercial entity, it’d have been imminently lendable to secure working capital,” he said.
“We heard that same story countless times among similar companies like ours. There was a real lack from banks of understanding the quality of these contracts.”
The result was the 2019 formation of Leonid Capital Partners (LCP), a Huntington Beach-based firm that lends to small startups with federal government contracts for highly technical work in fields such as software, biotech and engineering.
$200M Credit Line
The company’s found believers in its business plan.
Last month, Leonid secured a $200 million credit facility from Chicago-based Victory Park Capital, an alternative investment firm specializing in private credit and with about $4.7 billion in assets under management.
The credit facility will be used to leverage Leonid’s first institutional fund, Leonid Opportunities Fund 1 LP, which was oversubscribed. It also comes on top of $40 million previously raised from family offices and friends.
“With experience in government contract procurement and execution, the financial services sector, and government-funded research, the LCP team is uniquely suited as a capital partner to government contractors pursuing innovative projects,” Victory Park Partner Gordon Watson said in a statement. “We believe strongly in LCP’s mission and are pleased to be partnering with them.”
Earlier this month, Leonid announced Jim Geurts, a former Undersecretary of the Navy, and Brian Hibbeln, a former Assistant Deputy Undersecretary of Defense, have joined its board of advisors.
Lay, who earned a Ph.D. in neurobiology from the UCI, has monitored drug use at the Scripps Research Institute and conducted fundamental research in ischemic strokes.
Lay co-founded Leonid with James Parker, a trained astrophysicist who has worked as a NASA Flight Controller and at a variety of privately held and publicly traded companies.
They both earned MBAs from USC.
They said it’s understandable why banks don’t lend to small firms working for the federal government, because their contracts can be canceled with a 30-day notice without penalty.
“The banks shy away from that binary cancellation risk,” Parker said.
“They don’t want to loan money against future cash flow streams that could disappear effectively overnight.”
The pair conducted a deep dive into federal contracts, collecting 2 terabits bits of publicly available information on federal contracts going back two decades.
“Compared to astrophysics, the math was easy,” Parker quipped.
They discovered that the cancellation rate for special defense-related contracts was about 0.1%.
Banks don’t have the expertise to size up the contracts, the pair said. For example, one of the company’s first clients had a $2 million contract with the Space Force.
“He couldn’t get bankers to return phone calls,” Parker recalled. “I asked him to describe what he was doing. He said, ‘I’m trying to solve quantum key encryption by a proton entanglement on two satellites.’ I told him that the banker probably didn’t understand six of those words. I do.”
Leonid lends anywhere from $1 million to $25 million, or up to 50% of the future value of the contract.
It charges an interest rate ranging from 18% to 27%, which while it may cause sticker shock for some, is comparable to high-yield segment of the market, Parker said.
Also, the owners don’t have to cede a portion of their company as they would with venture capital.
“One of our biggest selling points is we are non-dilutive capital,” Parker said. “We don’t ask for personal guarantees. Our clients come back repeatedly.
“These are small, early-stage companies that have no appreciable assets. Our entire thesis is based on the government contract is an off-balance sheet asset that the market has mispriced the risk.”
Leonid also donates 50% of its after-tax profits to organizations that support military families and veterans.
“These men and women, along with their families, are taking significant risks without which, our market and our business would not exist,” Parker said. “We felt it was imperative to acknowledge them in the foundational principles of our organization.”
The company’s founders note that the Defense Department is the most resilient part of the government budget, having risen 6.2% annually since 1960, including 13% in the past five years.
“It always goes up,” Parker said of the DoD’s budget. “One thing our investors like is that it’s completely uncorrelated to the greater market. It does not care what the stock market is doing.
“Weirdly, it plows through geopolitical climate. It’s not affected by presidential tenure. National security is the last bipartisan policy we have in this country.”
To date, Leonid, which has nine employees, has loaned more than $45 million, grossing a return of 24.2% on its portfolio.
“We believe we invented this concept,” Parker said. “We have never run across anyone else who does this. There’s no reason that this cannot be a multibillion-dollar asset class.”
Lay is intrigued by the possibilities of helping numerous entrepreneurs.
“We meet these amazing entrepreneurs who are trying to solve mission critical problems for the government within science, medicine and national security,” Lay said.
“They’re looking for catalyst, dry powder. This is how we can help not one, not 10, but thousands. I love it.”
The Soviet Doctor Who Inspired a Name
Leonid Capital Partners took its name partially from an annual meteor storms every November.
The other reason was to honor Leo Levinson, the grandfather of the wife of Leonid co-founder James Parker.
The grandfather, a Jewish doctor who headed OB-GYN in the Soviet Union, once saved the life of the wife of a prominent KGB officer.
The officer agreed to help the doctor’s daughter and husband go on a honeymoon outside the country, which at that time limited foreign travel.
After the daughter and her husband defected on their honeymoon, Levinson and his wife lost their jobs as doctors in the Soviet Union. The couple eventually made it to the U.S.
“Leo came here not knowing English,” Parker said. “He passed the medical board. He got a job at Kaiser. He retired as a doctor. He bought his home in Southern California. He loved this country more than anyone I’ve ever met.”
Naming the company after Leo “seemed like a fitting tribute. He was a great man, not just to my wife, but all of us. He was the American dream.”