U.S. Startups Taking on Debt(bloomberg.com)
bloomberg.com
U.S. Startups Taking on Debt
https://www.bloomberg.com/news/articles/2016-12-19/u-s-startups-are-piling-on-debt
69 comments
This article confirms that the low interest capital days are coming to an end. Porsche too thought they could grow with debt. Then the low interest capital ran out and they got bought by Volkswagen.
I think you're grossly under represending the porsche thing. Porsche did a very very well executed short squeeze on VW and very nearly succeeded in acquiring VW.
Look it up. It was a very ballsy move. Even by failing, it still went down in history as a pretty masterful move. It also caused Germany to change their accounting laws around things such as that. In the US an equivalent move would be illegal. The US learned from Short Squeezes when the NY City Council tried to punish Cornelius Vanderbilt and he exacted revenge on them.
Look it up. It was a very ballsy move. Even by failing, it still went down in history as a pretty masterful move. It also caused Germany to change their accounting laws around things such as that. In the US an equivalent move would be illegal. The US learned from Short Squeezes when the NY City Council tried to punish Cornelius Vanderbilt and he exacted revenge on them.
I've been saying for years that anyone who believes silicon valley is in a bubble needs to put their money where their mouth is and short SVB stock.
Is this a bubble, and if so, when will it pop?
Sometimes debt is cheaper than VC money, if you have the cash flow to pay it back. If sales tank, and your cash flow slows down, you'll learn how quickly debt is not always cheaper :) In the article, the first company mentioned talks about how sales doubled in a year. Well, and an anything that grows that fast can shrink that fast, too. VC money can have really favorable payment terms for a company that needs to keep cash within the company to grow.
I don't know if it's just me, but I feel like a majority of the HN community seems to lean towards building a sustainable business without the need to take on outside capital that adds debt to the business. I definitely agree with that sentiment, however I love a nuanced article like this which doesn't paint debt as an entirely "bad" thing that needs to be avoided at all costs.
This was an awesome article to read as it balances the risks and possible advantages that taking on debt can bring a small company.
This was an awesome article to read as it balances the risks and possible advantages that taking on debt can bring a small company.
It isn't a bad thing, its a tool. You are taking money from the future and bringing it into the present and in so doing adding to your burn rate. But the fact that rates are really low is pretty spot on. If you can get 3 - 5% rates on 10 or 15 year notes that is a good thing.
They do however sit at the very front of the line in a sale, (even before your investors) and that can make some investors a bit nervous.
They do however sit at the very front of the line in a sale, (even before your investors) and that can make some investors a bit nervous.
It's great if you can take your time to get bootstrapped and build something sustainable, but sometimes you're Sidecar and you get Ubered by a company with seemingly infinite backing and you stand no chance, so you have to accelerate or be left in the dust by someone much hungrier. Same with businesses such as Homejoy / Handy where you need to be hugely unprofitable for a while until all of your competition dies out and then it's a winner-take-all market with you being the monopoly and reaping all of the benefits. It's a strategy, at the end of the day.
Or you can choose a smaller niche where you can't be ubered. The hedonistic value of money has a very steep downward slope.
HN community seems to lean towards building a sustainable business
Do you mean relative to the startup scene / community in general? The general population? Other tech / startup online community? Or did you mean within HN itself where more people lean towards the sustainable business model?
I feel the exact opposite if we're talking relative to other segments of society. Most people I talk to don't know about the VC funding model.
Do you mean relative to the startup scene / community in general? The general population? Other tech / startup online community? Or did you mean within HN itself where more people lean towards the sustainable business model?
I feel the exact opposite if we're talking relative to other segments of society. Most people I talk to don't know about the VC funding model.
The issue is that general startups want cash to fuel their development where as HN people tend to want a "workable model" and then expanding using VC cash or debt.
I find that most people really believe in bootstrapping right until the very moment that they have a realistic chance of taking on institutional funding.
The reality is that there is no single right way to build a company. You can find lots of survivors who used all sorts of capitalization strategies.
The reality is that there is no single right way to build a company. You can find lots of survivors who used all sorts of capitalization strategies.
The biggest issue with funding is that, many times, the only reason you need it is that someone else has it. If you are competing for market share with someone willing/able to take losses, it's not going to be a pretty fight. The best you can do is take things one step at a time and hope the other guys screw up, but there's a very real chance you're screwed.
Really? Like convertible notes?
The author is contrasting "venture deals" against "borrowing capital" so I'm pretty sure they mean conventional loans with banks.
EDIT: The author is totally talking about venture debt and buried the lede. So yes, convertible notes as far as I can tell. Very misleading.
EDIT: The author is totally talking about venture debt and buried the lede. So yes, convertible notes as far as I can tell. Very misleading.
Venture debt is very different to convertible notes. Venture debt usually involves warrants and preferred shares, they'll take IP as collateral, and are only offered from a few banks and other financial institutions. They often have defined interest payments as well.
We had a $X million dollar venture note from SVB at a previous company that needed to raise cash, it was helpful to keep the company afloat but definitely came with some pretty onerous terms (as to be expected). It was much different to the convertible notes that started the company.
https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_...
We had a $X million dollar venture note from SVB at a previous company that needed to raise cash, it was helpful to keep the company afloat but definitely came with some pretty onerous terms (as to be expected). It was much different to the convertible notes that started the company.
https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_...
Part of the issue is that the author goes through no effort to actually explain WTF they are talking about, while making it sound like these startups are raising capital with no equity on the line.
Uber actually is. They've been taking on straight debt.[1]
[1] https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-...
[1] https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-...
Wow! Uber is quite the domino :-)
> "Folks don't want to do down rounds or flat rounds," says Haim Zaltzman, a partner at law firm Latham & Watkins LLP, which has handled well over 100 such loan transactions so far this year. "Debt allows you to get around that."
Eh. I'm not too into the whole startup scene these days, and I haven't been exactly fishing for VC deals in today's market, but I believe that if your startup is only getting term sheets that provide you with a deal that forces you down or flat, you should seriously be considering looking at your business fundamentals before you are trying to raise funding by other means.
VC is speculative and looks for returns with dilution; if your company starts to go belly up, you can look at some acquihire or insta-acquisition through the VC's network so the VC firm can save face and see some ROI.
However, if you can't make your debt payments, banks don't care. They have no LPs to answer to, just their balance sheets. They will gladly step in with their attorneys and carve out any asset they can from your precious company. Caveat emptor. I have always been told by trusted GPs that debt is useful in very, very limited situations, and it seemed to me that the dreams of the entrepreneurs getting stuck with debt deals are already grasping at straws. I think there's a point at which you need to know when to quit.
Eh. I'm not too into the whole startup scene these days, and I haven't been exactly fishing for VC deals in today's market, but I believe that if your startup is only getting term sheets that provide you with a deal that forces you down or flat, you should seriously be considering looking at your business fundamentals before you are trying to raise funding by other means.
VC is speculative and looks for returns with dilution; if your company starts to go belly up, you can look at some acquihire or insta-acquisition through the VC's network so the VC firm can save face and see some ROI.
However, if you can't make your debt payments, banks don't care. They have no LPs to answer to, just their balance sheets. They will gladly step in with their attorneys and carve out any asset they can from your precious company. Caveat emptor. I have always been told by trusted GPs that debt is useful in very, very limited situations, and it seemed to me that the dreams of the entrepreneurs getting stuck with debt deals are already grasping at straws. I think there's a point at which you need to know when to quit.
"you should seriously be considering looking at your business fundamentals before you are trying to raise funding by other means."
+ They may not have a choice. A lot of things require working capital in one way or another.
"They will gladly step in with their attorneys and carve out any asset they can from your precious company." - thing is most startups have zero in the way of assets. So ... there's not a lot to collect upon. It's not like writing off a mortgage, wherein they can recoup 75% of the loan on foreclosure.
The whole premise of this article is upside-down ... why are startups with limited ability to collateralize even getting debt at any price?
I'll bet that this 'phenom' is happening for a variety of very specific reasons, and that 'debt' happens to be the common instrument, hence the basis for the article. If they broke it down into the various categories, we might get a better picture.
+ They may not have a choice. A lot of things require working capital in one way or another.
"They will gladly step in with their attorneys and carve out any asset they can from your precious company." - thing is most startups have zero in the way of assets. So ... there's not a lot to collect upon. It's not like writing off a mortgage, wherein they can recoup 75% of the loan on foreclosure.
The whole premise of this article is upside-down ... why are startups with limited ability to collateralize even getting debt at any price?
I'll bet that this 'phenom' is happening for a variety of very specific reasons, and that 'debt' happens to be the common instrument, hence the basis for the article. If they broke it down into the various categories, we might get a better picture.
If your company starts to go belly up and you get acquihired, you'll probably walk away as empty handed as a bank default, due to liquidation preferences and other terms in VC funding.
Founders aren't always in it just for the bank account. Between going belly up and shuttering, and going belly up and giving their team a chance in another company, existing customers, etc., acquihire is preferable to getting carved up. At the very least, founders need to save face too.
Depends on the terms of the acquisition. From what I've read, they often favor founders and aren't great outcomes for investors. E.g., the windfall is often in the retention package to maximize for the acquirer who has the most leverage.
Those are some high interest rates. Are there equivalent firms in Europe? High Yield in Euros is like half of the interest rates in this articles.
Debt in the limit is the same as equity, from the perspective of investors. You end up betting fundamentally on the solvency of the business rather than how much of a (positive) return they will generate.
Wow. 14% is really damn high.
I wonder how much the emergence of fintech is affecting this trend?
Debt is a powerful, but often fairly complex, financial instrument. Much like venture capital. The difference is that most folks in the financial industry are intimately familiar with debt but relatively unfamiliar with venture capital; or worse, to those coming from a PE background VC can often appear completely insane.
The growth of fintech has indirectly added a whole cohort of founders and entrepreneurs who are much more likely to know how to work with debt and be able to use it in tandem (or in place of) venture capital.
Debt is a powerful, but often fairly complex, financial instrument. Much like venture capital. The difference is that most folks in the financial industry are intimately familiar with debt but relatively unfamiliar with venture capital; or worse, to those coming from a PE background VC can often appear completely insane.
The growth of fintech has indirectly added a whole cohort of founders and entrepreneurs who are much more likely to know how to work with debt and be able to use it in tandem (or in place of) venture capital.
Last year venture capitalists plowed a record $79 billion into startups at often unsustainable valuations
I'm confused. The CEO of Persado is quoted as saying "interest rates are low," while the article says that Metamarkets is paying 14% on a loan cut in Oct--for comparison, the Merrill Triple-C-Rated index ("extremely speculative" junk bonds) is under 12%. So while it's true that UST base rates are low, that doesn't seem to be a factor in this funding. Sounds like a story about a few banks goosing earnings with risky loans and company insiders/VCs getting more upside "if things work out" and far less of those pesky loses if they don't, very much like the speculative real estate development loans in the 80s that made for a big but very short party.
The very premise of the article:
"With fewer companies getting funded these days, many startups are opting to borrow money instead. "
Leaves some serious financial issues.
Generally speaking - if you could raise debt, you wouldn't ever want to raise equity.
The whole point of raising equity surrounds the fact that there's too much risk for debt.
If you can get good terms on a deal, and are not too leveraged, then every VC should be wanting the company to have debt in lieu of equity. Why would anyone want to dilute if they don't have to?
What on earth are these startups using as collateral? Equipment? Receivables?
And given the likelihood of a startup going bust, why are banks even offering debt, at any price?
I can definitely understand a 'bridge loan' for some financial operation - or even holding off for better valuations ... or again, some kind of low-leverage on solid receivables for an SaaS or something ...
If someone has some experience with this, maybe they can chime in?
"With fewer companies getting funded these days, many startups are opting to borrow money instead. "
Leaves some serious financial issues.
Generally speaking - if you could raise debt, you wouldn't ever want to raise equity.
The whole point of raising equity surrounds the fact that there's too much risk for debt.
If you can get good terms on a deal, and are not too leveraged, then every VC should be wanting the company to have debt in lieu of equity. Why would anyone want to dilute if they don't have to?
What on earth are these startups using as collateral? Equipment? Receivables?
And given the likelihood of a startup going bust, why are banks even offering debt, at any price?
I can definitely understand a 'bridge loan' for some financial operation - or even holding off for better valuations ... or again, some kind of low-leverage on solid receivables for an SaaS or something ...
If someone has some experience with this, maybe they can chime in?
Debt financing is usually massively cheaper than equity financing. If you need working capital and can pay back loans with decent terms, then you should almost always prefer debt. I could be wrong, but I get the impression startups either don't understand how to leverage debt or it's just not sexy. No one gets a TechCrunch article written about their new 500k loan from Wells Fargo that they need for working capital. VCs aren't exactly keen on revenue producing startups going to a bank instead of them either.
Another possibility could be they are no where near to producing the revenue needed to make payments or pay off a loan and equity has no hard deadline or immediate revenue requirements. Unfortunately, that's kind of a terrible cycle as a company with cheap debt and revenue is likely to be built on better fundamentals than one that has no idea when it will have revenue.
Another possibility could be they are no where near to producing the revenue needed to make payments or pay off a loan and equity has no hard deadline or immediate revenue requirements. Unfortunately, that's kind of a terrible cycle as a company with cheap debt and revenue is likely to be built on better fundamentals than one that has no idea when it will have revenue.
"could be they are no where near to producing the revenue needed to make payments or pay off a loan a"
---> Then there is no way they could feasibly get any debt.
That's the odd part of all of this.
---> Then there is no way they could feasibly get any debt.
That's the odd part of all of this.
Good point. That part doesn't make any sense. I guess what lenders we're doing before the recession in the housing market didn't make sense either though.
>>Unlike venture investors who typically bet one investment will hit big and compensate for duds, lenders get no upside if a startup succeeds.
Obviously not written by a lender. There are countless schemes for lending money. These are custom contracts, not credit cards. At the simplest, a lender can delay repayment for a period of years in full knowledge that the business may fail between now and then. The startup accepts an otherwise ridiculous interest rate. Or a hybrid approach can be made whereby the later debt can be settled with stock, stock valuated when the debt is due. Maybe the stock takes off and repayment is easy, or maybe the stock tanks and the lender takes substantial ownership of the company. The deal still begins life as a loan.
Lending money to a business and buying a shares in that business are not mutually exclusive concepts. There is an entire range of schemes available between those two options.
Obviously not written by a lender. There are countless schemes for lending money. These are custom contracts, not credit cards. At the simplest, a lender can delay repayment for a period of years in full knowledge that the business may fail between now and then. The startup accepts an otherwise ridiculous interest rate. Or a hybrid approach can be made whereby the later debt can be settled with stock, stock valuated when the debt is due. Maybe the stock takes off and repayment is easy, or maybe the stock tanks and the lender takes substantial ownership of the company. The deal still begins life as a loan.
Lending money to a business and buying a shares in that business are not mutually exclusive concepts. There is an entire range of schemes available between those two options.
The article specifically mentions commercial bank lenders, which are regulated. While I'm sure there are non-bank lenders in this space, a commercial bank can't delay repayment without a charge to the loan-loss reserve, and taking stock in lieu of payment, unless the stock is good as cash, is also a loan impairment. Unregulated commercial lenders have more freedom, but they are also constrained by GAAP.
So they take a hit on the loan value which their funders might expect give tge returns they aim to produce.
Junk bonds are nothing new.
Junk bonds are nothing new.
The article is not wrong, but I work in this space so maybe I can add some context from I have seen:
The author seems a bit hyperbole happy; yes debt volume is up but it's nothing to foam at the mouth over...Phrases like "spiked in 2016", "surged 19%", "doubled last year's total" (Wellington did 5 loans last year, so "double" is only 5 more loans) this language makes "piling on debt" sound bigger than it really is...
If you look at the growth of startups over the past few years and compare that to debt volume: then up 19% or doing 5 more debt deals is in line with what would be expected and maybe even a bit low.
Second point: Without naming names, and without contradicting the article, a significant portion of debt taken on by startups is mezz debt or bridge loans. In the cases of bridge loans for example, more mature startups often use bridge loans prior to an expected IPO. So with the IPO market bottlednecked at the moment, the increase in debt deals this year is expected as it partly reflects startups waiting out an upcoming increase in IPOs (hopefully).
Connected to planning for IPOs is in some cases company boards and/or their VCs will encourage small debt deals to help train CEOs and CFOs for the "big leagues" after they IPO. New, relatively young, first-time CEOs and CFOs have no experience managing a complex capital structure of equity and debt. So boards and VCs encourage getting their feet wet with a bit of debt while still private. You see BS mini acquisitions by startups for similar reasons. If this sounds like boards and VCs treating some CEOs/CFOs like children who need training wheels, that is correct.
Lastly, the article makes it seem like a lot of startups are turning to debt because VC funding has dried up for them or they want to avoid printing a down round. This is not entirely accurate. While VC investors' approach might be generalized as thinking about 'reward before risk', debt lenders looks at 'risk before reward'. SO if a startup is too risky for VC capital, 9 times out of 10 they are too risky for debt as well. Any startups who think they have loans as a backup option if they can't raise their next round are in a for a tough wake up call. The startups that get debt are relatively healthy and will have both equity or debt as options. Or they just need a small amount of money and offer recourse assets. Debt is not as attractive as one might think if you actually do the math side by side and look at the convenants.
The author seems a bit hyperbole happy; yes debt volume is up but it's nothing to foam at the mouth over...Phrases like "spiked in 2016", "surged 19%", "doubled last year's total" (Wellington did 5 loans last year, so "double" is only 5 more loans) this language makes "piling on debt" sound bigger than it really is...
If you look at the growth of startups over the past few years and compare that to debt volume: then up 19% or doing 5 more debt deals is in line with what would be expected and maybe even a bit low.
Second point: Without naming names, and without contradicting the article, a significant portion of debt taken on by startups is mezz debt or bridge loans. In the cases of bridge loans for example, more mature startups often use bridge loans prior to an expected IPO. So with the IPO market bottlednecked at the moment, the increase in debt deals this year is expected as it partly reflects startups waiting out an upcoming increase in IPOs (hopefully).
Connected to planning for IPOs is in some cases company boards and/or their VCs will encourage small debt deals to help train CEOs and CFOs for the "big leagues" after they IPO. New, relatively young, first-time CEOs and CFOs have no experience managing a complex capital structure of equity and debt. So boards and VCs encourage getting their feet wet with a bit of debt while still private. You see BS mini acquisitions by startups for similar reasons. If this sounds like boards and VCs treating some CEOs/CFOs like children who need training wheels, that is correct.
Lastly, the article makes it seem like a lot of startups are turning to debt because VC funding has dried up for them or they want to avoid printing a down round. This is not entirely accurate. While VC investors' approach might be generalized as thinking about 'reward before risk', debt lenders looks at 'risk before reward'. SO if a startup is too risky for VC capital, 9 times out of 10 they are too risky for debt as well. Any startups who think they have loans as a backup option if they can't raise their next round are in a for a tough wake up call. The startups that get debt are relatively healthy and will have both equity or debt as options. Or they just need a small amount of money and offer recourse assets. Debt is not as attractive as one might think if you actually do the math side by side and look at the convenants.
> SO if a startup is too risky for VC capital, 9 times out of 10 they are too risky for debt as well. Any startups who think they have loans as a backup option if they can't raise their next round are in a for a tough wake up call.
Reminds me of the one startup we once partnered with that were entirely bank funded through a major R&D effort. I'm still in awe at the financial discipline it took them, given that the bank released money in tranches equivalent to what he needed for 1-2 months at a time, entirely contingent on meeting extremely narrow performance targets to convince the bank they were on track and still met the risk profile. Mess up the slightest little bit even one month, and they'd be totally at the mercy of their bank manager. The bank saw it as borderline in terms of their risk.
Meanwhile, if they'd gone to a VC with the business in the state it was in, the VCs would be metaphorically throwing stacks of money at the company.
Reminds me of the one startup we once partnered with that were entirely bank funded through a major R&D effort. I'm still in awe at the financial discipline it took them, given that the bank released money in tranches equivalent to what he needed for 1-2 months at a time, entirely contingent on meeting extremely narrow performance targets to convince the bank they were on track and still met the risk profile. Mess up the slightest little bit even one month, and they'd be totally at the mercy of their bank manager. The bank saw it as borderline in terms of their risk.
Meanwhile, if they'd gone to a VC with the business in the state it was in, the VCs would be metaphorically throwing stacks of money at the company.
Traditionally debt has been seen as the cheaper way to capitalize a business. It's just that start ups are terrible credit risks and had no ability to get loans. Obviously every situation is unique. The freedom of a lot of money now might be worth giving up equity, especially in a market where first mover is so significant.
But if you use debt, all the upside is yours.
I still think debt is better, especially because a lot of equity comes with with debt-like terms like liquidation preferences. So it's basically the worst part of debt and equity combined.
But if you use debt, all the upside is yours.
I still think debt is better, especially because a lot of equity comes with with debt-like terms like liquidation preferences. So it's basically the worst part of debt and equity combined.
Does debt have first preference if a business is sold? If so, it would take a total catastrophe for the principle to be wiped out.
Debt usually is senior and paid first if a business is sold. But not always. In the case of startup debt, loan terms can be non-standard because VCs who own preferred shares don't want to subordinate their stake. It depends on the terms sheets, debt might be senior to everything or it could be treated as equal to the later stage VC investors preferred shares preference (also called "pari passu" if you want to sounds like an arrogant tool lawyer).
You're right it would take a surprise total catastrophe for principle to be wiped out. But the principle isn't always the main worry for startup lenders. Well it is, but the loan terms are written in such a way lenders are confident they will get some or all of the principle back. The big worry and risk for lenders is usually time. Being paid back too soon or being paid very late are both risks (the latter happens in bankruptcy cases where court system can take a long time to get lenders their money back).
You're right it would take a surprise total catastrophe for principle to be wiped out. But the principle isn't always the main worry for startup lenders. Well it is, but the loan terms are written in such a way lenders are confident they will get some or all of the principle back. The big worry and risk for lenders is usually time. Being paid back too soon or being paid very late are both risks (the latter happens in bankruptcy cases where court system can take a long time to get lenders their money back).
From a finance perspective debt financing should be cheaper than equity financing. Sin e equity is more risky it requires a greater rate or return.
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With all due respect to the OP, I think debt is amazing and a great and sensible solution of financing a company - that VCs want to distract you from for their own benefit.
If all factors point into the right direction, why would you give VCs a free ride with a steaming train instead of just going all in yourself and personally taking on a bank loan? (especially in the way more conservative and less trigger happy VC environment in Europe)
No doubt it's hard (due to much heavier regulations around bank loans), but with the right KPIs it's really not much harder than raising a round.
Sociomantic did it. We did it too - and by now financed our own Series B with revenue.
Way too many people trying to build a startup instead of building a company...
If all factors point into the right direction, why would you give VCs a free ride with a steaming train instead of just going all in yourself and personally taking on a bank loan? (especially in the way more conservative and less trigger happy VC environment in Europe)
No doubt it's hard (due to much heavier regulations around bank loans), but with the right KPIs it's really not much harder than raising a round.
Sociomantic did it. We did it too - and by now financed our own Series B with revenue.
Way too many people trying to build a startup instead of building a company...
>, why would you give VCs a free ride with a steaming train instead of just going all in yourself and personally taking on a bank loan?
You mean "personally" as in the young company has no material revenue -- and therefore for any "business loan" the founder applies for, the conservative banks will always demand collateral of personal assets including house, car, retirement savings, etc? (The young startup has no business assets such as airplanes, factories, datacenters, etc for the bank to seize in case of non-payment.)
Well then, the "why" should be obvious: VCs can give orders-of-magnitude more money than personally-collateral-backed bank loans can provide. Also, the VCs (the good ones) can dive into their rolodex to help you hire hard-to-find executives. A bank loan officer doesn't have the same motivations.
E.g. In 2005, Mark Zuckerberg got $12.5 million from VC Accel Partners. There is no bank that will give a 20-year-old college dropout with no revenue a $12.5 million loan. Yes, his parents were upper-middle class but I doubt Mark had $12 million in personal assets to secure as collateral for a bank loan.
>, but with the right KPIs it's really not much harder than raising a round.
I think it's very hard to concoct a scenario where a startup founder has virtually equal opportunity to secure $1 million bank loan or $1 million in VC investment -- and the only reason he chose the VC was that the founder didn't have the financial wisdom to choose the debt. I can't think of a case study where that suboptimal decision actually happened.
In other words, the type of business (lifestyle/bootstrap/niche vs mainstream grow exponentially fast) or lifecycle stage (early no revenue vs mature with revenue) already predetermines a path of debt vs VC investment.
You mean "personally" as in the young company has no material revenue -- and therefore for any "business loan" the founder applies for, the conservative banks will always demand collateral of personal assets including house, car, retirement savings, etc? (The young startup has no business assets such as airplanes, factories, datacenters, etc for the bank to seize in case of non-payment.)
Well then, the "why" should be obvious: VCs can give orders-of-magnitude more money than personally-collateral-backed bank loans can provide. Also, the VCs (the good ones) can dive into their rolodex to help you hire hard-to-find executives. A bank loan officer doesn't have the same motivations.
E.g. In 2005, Mark Zuckerberg got $12.5 million from VC Accel Partners. There is no bank that will give a 20-year-old college dropout with no revenue a $12.5 million loan. Yes, his parents were upper-middle class but I doubt Mark had $12 million in personal assets to secure as collateral for a bank loan.
>, but with the right KPIs it's really not much harder than raising a round.
I think it's very hard to concoct a scenario where a startup founder has virtually equal opportunity to secure $1 million bank loan or $1 million in VC investment -- and the only reason he chose the VC was that the founder didn't have the financial wisdom to choose the debt. I can't think of a case study where that suboptimal decision actually happened.
In other words, the type of business (lifestyle/bootstrap/niche vs mainstream grow exponentially fast) or lifecycle stage (early no revenue vs mature with revenue) already predetermines a path of debt vs VC investment.
Granted, especially for business models with low initial revenue / high lock-in / winner-takes-all properties and for young founders without large assets, you are completely right that there's often a lack of other options.
That being said, other sources of funding than VC (debt, mezzanine capital, government grants, incentivized programs, early temporary monetization options or getting experienced execs as cofounders for real shares (not the usual .5 options)) instead of paying them hard cash with borrowed money later on are often totally overlooked by startups IMHO for their own detriment.
That being said, other sources of funding than VC (debt, mezzanine capital, government grants, incentivized programs, early temporary monetization options or getting experienced execs as cofounders for real shares (not the usual .5 options)) instead of paying them hard cash with borrowed money later on are often totally overlooked by startups IMHO for their own detriment.
Where can I read more about alternate funding methods? It looks like you have a system on your mind.
I think you guys are both right. And I'm sure one could construct some sort of venn diagram for startup funding with circles for equity, debt and bootstrapping; where a given startup is a good match for one or more funding choices (based on its biz model, industry, geography, founders, etc..).
(By the way congrats on financing your Series B with revenue, that is awesome!).
Just wanted to add one point in the equity vs debt debate is 'in theory' once a startup gets big enough doing the math on choosing equity or debt is very different. Once a startup is a real company and reasonably calculates how much money it needs and what it expects to earn on that money, an "optimal" capital structure calculation starts to emerge [1] and VCs and banks will compete for your business.
For a healthy, growing startup, if selling a certain % of your equity to a VC looks unattractive compared taking out a bank loan then your equity valuation is being mispriced here. Negotiate it. Conversely if a bank loan looks unattractive compared to VC equity offers (because the bank's convenants are too burdensome and your monthly interest/principal payments pull too much cash away from your growing business then the lender is mispricing your borrower risk). Negotiate it.
To follow on the Facebook example above, I believe they started mixing equity and debt almost immediately as early as 2004 [2]. Their seed investors backed their credit line (WTI invested $25k in equity and provided a $600k credit line). Later, FB took on $100M in debt from TriplePoint about the same take they sold .08% for $120M ($15B post). If you do the math here, then diluting ownership by .08% for $120M that you don't have to pay back vs. writing checks for $150M to pay back a loan over the next few years, the equity starts to look pretty attractive.
[1] Optimal Capital Ratio: One might disagree with how this is done or what it means but calculating an optimal capital structure is a thing: http://pages.stern.nyu.edu/~adamodar/pdfiles/acf2E/presentat...
[2] FB made some good choices early. I wonder how much equity and advise from Thiel played a factor: http://dealbook.nytimes.com/2012/02/01/tracking-facebooks-va...
(By the way congrats on financing your Series B with revenue, that is awesome!).
Just wanted to add one point in the equity vs debt debate is 'in theory' once a startup gets big enough doing the math on choosing equity or debt is very different. Once a startup is a real company and reasonably calculates how much money it needs and what it expects to earn on that money, an "optimal" capital structure calculation starts to emerge [1] and VCs and banks will compete for your business.
For a healthy, growing startup, if selling a certain % of your equity to a VC looks unattractive compared taking out a bank loan then your equity valuation is being mispriced here. Negotiate it. Conversely if a bank loan looks unattractive compared to VC equity offers (because the bank's convenants are too burdensome and your monthly interest/principal payments pull too much cash away from your growing business then the lender is mispricing your borrower risk). Negotiate it.
To follow on the Facebook example above, I believe they started mixing equity and debt almost immediately as early as 2004 [2]. Their seed investors backed their credit line (WTI invested $25k in equity and provided a $600k credit line). Later, FB took on $100M in debt from TriplePoint about the same take they sold .08% for $120M ($15B post). If you do the math here, then diluting ownership by .08% for $120M that you don't have to pay back vs. writing checks for $150M to pay back a loan over the next few years, the equity starts to look pretty attractive.
[1] Optimal Capital Ratio: One might disagree with how this is done or what it means but calculating an optimal capital structure is a thing: http://pages.stern.nyu.edu/~adamodar/pdfiles/acf2E/presentat...
[2] FB made some good choices early. I wonder how much equity and advise from Thiel played a factor: http://dealbook.nytimes.com/2012/02/01/tracking-facebooks-va...
Loans can still be a great option - and can offer larger amounts without personal guarantees (e.g.: up to a million with revenue-based financing).
Debt's a great strategy for companies looking to stave off venture capital so that they can improve their metrics in the short run and set themselves up for better term sheets. I know several founders who have saved millions in founder equity as a result of growing with debt financing first.
Debt's a great strategy for companies looking to stave off venture capital so that they can improve their metrics in the short run and set themselves up for better term sheets. I know several founders who have saved millions in founder equity as a result of growing with debt financing first.
>and by now financed our own Series B with revenue
Out of curiosity... how does one finance their own Series B with revenue? Did you actually issue new stock?
>Way too many people trying to build a startup instead of building a company...
Very wise words.
Out of curiosity... how does one finance their own Series B with revenue? Did you actually issue new stock?
>Way too many people trying to build a startup instead of building a company...
Very wise words.
If you are young and have no assets, you won't get a loan of much value.
If you aren't young and have assets, ones that your family relies on, then you are risking the very foundation of your family--your home, car, savings, etc.
There's a very good reason loans are used more than they are.
If you aren't young and have assets, ones that your family relies on, then you are risking the very foundation of your family--your home, car, savings, etc.
There's a very good reason loans are used more than they are.
> by now financed our own Series B with revenue.
Do you mean "didn't need to raise a second round because we are profitable/growing?" Way to go!!
Do you mean "didn't need to raise a second round because we are profitable/growing?" Way to go!!
>why would you give VCs a free ride with a steaming train instead of just going all in yourself and personally taking on a bank loan?
Because most startups fail?
And startups that VCs aren't interested in, even more so?
Because most startups fail?
And startups that VCs aren't interested in, even more so?
> And startups that VCs aren't interested in, even more so?
Do you have any reference or data to back this claim?
VCs often aren't interested in startups that don't aim to be a billion dollar business. And those might actually have a better chance of succeeding.
Do you have any reference or data to back this claim?
VCs often aren't interested in startups that don't aim to be a billion dollar business. And those might actually have a better chance of succeeding.
Exactly. DHH quite famously argues this point.
https://m.signalvnoise.com/reconsider-41adf356857f#.9npvz09a...
https://m.signalvnoise.com/reconsider-41adf356857f#.9npvz09a...
Sure, and they are great, but those are not the startups the article talks about though.
Average deal size is $15m which means that the company probably has some mix of equity and debt in their capital structure. Equity can be used to cushion variance in debt servicing payments. Ultimately if you're taking on debt you're expecting that your your ROI is exceeding your debt payment. While some companies may default, an equity position may not have saved them either. Net-net, smart use of debt could generate better returns for VC as an asset class as companies will suffer less dilution and it'll drive stronger selection for companies generating positive cash flows.
I think now is a perfect opportunity for the startup community to work toward changing this. In other words, I think dependence on VCs (or loans in general) for success builds an ecosystem filled with unicorns and everyone else. I think that's incredibly unsustainable and surprised not more people are trying to fix this.
What I think the ecosystem of startups in general (not just tech startups) needs is a continuum where it's more or less obvious how to "plug into" an ecosystem and succeed. And as long as your company is producing a satisfactory product / service (to the customer) you're more than likely going to succeed.
Will this transition happen within our lifetimes? Perhaps not, but I think it's an important thing that needs to be fixed for the future of civilization. Do I even know exactly what this other world will look like? Probably not, but I do believe it assumes there will be far fewer ultra wealthy and ultra poor, and a whole lot of middle class.
What I think the ecosystem of startups in general (not just tech startups) needs is a continuum where it's more or less obvious how to "plug into" an ecosystem and succeed. And as long as your company is producing a satisfactory product / service (to the customer) you're more than likely going to succeed.
Will this transition happen within our lifetimes? Perhaps not, but I think it's an important thing that needs to be fixed for the future of civilization. Do I even know exactly what this other world will look like? Probably not, but I do believe it assumes there will be far fewer ultra wealthy and ultra poor, and a whole lot of middle class.
Seems like the bubble is finally shrinking... i think dept can actually help an early company focus their effort - if you know you have to produce value, to meet your next payments - instead of 'oh, yeah i got a billion dollars - lets buy some art for the office'. I am always amazed when i read articles on how much money a (typical) unicorn (actually) looses... Granted it can take some money to build a user-base etc. But, woo... i would love if someone could calculate the cost of customer for some big ones... Or tell me how shit, without a business-model, gets founding millions high.
Umm... I donno. I think taking other peoples money in general is a bad thing due to psychology. It's very easy to spend other peoples money but you always think one time extra before you spend your own.
Many of these companies that take on huge VC rounds or take a lot of debt seem to often employ unnecessary many people, hire big unnecessary offices money that would never have been spent if it was their own money.
Sure I understand if you really need to grow fast, but even then I think many spend their money on unnecessary crap even when they have zero revenue.
The goal for every company should always be to maximize revenue and minimize the cost of doing business. People in the startup scene seems to forget that too often.
Many of these companies that take on huge VC rounds or take a lot of debt seem to often employ unnecessary many people, hire big unnecessary offices money that would never have been spent if it was their own money.
Sure I understand if you really need to grow fast, but even then I think many spend their money on unnecessary crap even when they have zero revenue.
The goal for every company should always be to maximize revenue and minimize the cost of doing business. People in the startup scene seems to forget that too often.
> maximize revenue and minimize the cost of doing business
Often doing both at the same time is difficult, and near impossible. To increase revenue you need a sales staff, and engineering time on building new features for new markets. Reducing costs requires your engineering staff, and maybe a business staff to negotiate with suppliers (or whatever your other inputs are). The engineers are often different kind of people. The type of engineer who is great at maximizing a process is probably not the same type of engineer who is good at rapid prototyping, and building something that "just works".
There's a transition in every startup that reaches a point of maturity where they start to build processeses, and start to rebuild existing systems. It's usually at the same time that the founding staff starts to leave.
Startups concentrate on Revenue, and hope they reach the level of worrying about costs.... and VC money makes that SO MUCH EASIER. Bootstrapping usually means you limit your input costs, which limits the rate of growth you can achieve.
Often doing both at the same time is difficult, and near impossible. To increase revenue you need a sales staff, and engineering time on building new features for new markets. Reducing costs requires your engineering staff, and maybe a business staff to negotiate with suppliers (or whatever your other inputs are). The engineers are often different kind of people. The type of engineer who is great at maximizing a process is probably not the same type of engineer who is good at rapid prototyping, and building something that "just works".
There's a transition in every startup that reaches a point of maturity where they start to build processeses, and start to rebuild existing systems. It's usually at the same time that the founding staff starts to leave.
Startups concentrate on Revenue, and hope they reach the level of worrying about costs.... and VC money makes that SO MUCH EASIER. Bootstrapping usually means you limit your input costs, which limits the rate of growth you can achieve.
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> The goal for every company should always be to maximize revenue and minimize the cost of doing business.
Startups don't forget that--they just focus on the former whereas established companies focus so hard on the latter that anything different looks unusual today.
Startups don't forget that--they just focus on the former whereas established companies focus so hard on the latter that anything different looks unusual today.
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Reasonably priced debt is issued with the expectation that most recipients will succeed and access to it is generally limited to entities with a stable business model already.
VC money is mostly issued with the expectation that most recipients will fail and it's priced accordingly.
A strongly performing 'real' company (i.e. one with a strong profit stream) will nearly always prefer debt to VC money in the same way a strongly performing public company will issue bonds over selling more shares--the later tending to be for companies in trouble.
VC money is mostly issued with the expectation that most recipients will fail and it's priced accordingly.
A strongly performing 'real' company (i.e. one with a strong profit stream) will nearly always prefer debt to VC money in the same way a strongly performing public company will issue bonds over selling more shares--the later tending to be for companies in trouble.
I really do not understand why anyone would would want to lend a startup money these rates (14%). it may sound like a high percentage but...
- nobody is ultimately responsible for the debt. if the company runs out of cash, money gone. you cannot go after the people who squandered your cash. 90% of startups fails early. it's like a slot machine but when you win, you get 14%.
- a recent strategy for companies is bankruptcy followed by a 'restart'. get rid of any debt and a lot of employees, keep the rest.
- take the money and run. the current system would enable unscrupulous ceo's to direct the money to themselves and let the company crash. a lender would lose his money.
lending to companies is broken. if you have ever seen a loan fail to repay itself, you will not make that mistake again. to enable lenders to have a reasonable guarantee they will see their money back, the system should be adjusted so that shareholders can be easily held (personally) responsible for the companies debt.
conclusion: debt is an amazing way to finance a startup, if you can get it. the last thing seems very doubtful. a lot of these startup lenders are likely to lose money.
- nobody is ultimately responsible for the debt. if the company runs out of cash, money gone. you cannot go after the people who squandered your cash. 90% of startups fails early. it's like a slot machine but when you win, you get 14%.
- a recent strategy for companies is bankruptcy followed by a 'restart'. get rid of any debt and a lot of employees, keep the rest.
- take the money and run. the current system would enable unscrupulous ceo's to direct the money to themselves and let the company crash. a lender would lose his money.
lending to companies is broken. if you have ever seen a loan fail to repay itself, you will not make that mistake again. to enable lenders to have a reasonable guarantee they will see their money back, the system should be adjusted so that shareholders can be easily held (personally) responsible for the companies debt.
conclusion: debt is an amazing way to finance a startup, if you can get it. the last thing seems very doubtful. a lot of these startup lenders are likely to lose money.
Of course Bezos left Wall Street to found Amazon so he already had wider connections that gave him more flexibility in financing.