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Karma-Duped: A Cautionary Tale About the Murky World of Venture Lending

80 points by ascertain 10y ago

a_small_island 10y ago
Interesting article. I'm interested in the financial schemes (of the venture lenders) in the upcoming series of articles or any anecdotes from HN members. This article was more introductory than informing...
- brudgers 10y ago
  The financial model is pretty much straight out of real estate development and private equity. The best up side for the lender is often being able to call the loan and take control of the asset. My anecdotal observations imply that this is pretty common outside Silicon Valley because it's the model the local yokel investors know through experience. The popularization of "startup" as a synonymous with "new business" and the common idea among founders that raising money and pitching investors and getting mentored is the first priority make happy hunting grounds for this type of investor. That's not to say there aren't vultures on Sand Hill Road, but the standard model there tends to have greater alignment of interests between founders and investors.
  - karmakarma1 10y ago
    I saw this a lot first hand doing commercial small business real estate. Hard money lenders give someone a loan to start a restaurant, and if it fails to meet the obligations of the loan, they can foreclose on the restaurant and other property or assets the person has signed as collateral. Taking money as a loan with a personal guarantee is always a very high risk situation and should be avoided unless you absolutely have to.
JackFr 10y ago
c.f http://www.complex.com/style/the-rise-and-fall-of-karmaloop http://www.complex.com/style/the-rise-and-fall-of-karmaloop
MichaelGG 10y ago
I'm not quite sure I understand. The owner signed a deal giving the lender the power to place people in the company, and prevent any recourse. > A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan. Crazy? Not to rub salt in, but I think the "make you" wording is telling here. No one made anyone take this loan. This is not crazy; it makes sense that one party might want to protect themselves from lawsuits. What's "crazy" is accepting such a deal, giving them access to the company. In essence, the owner put himself at complete odds with the lender. Indeed, it sounds like the lender had a huge incentive: loan X, if default, gain 2X. No one should have accepted it, but that doesn't mean it should be illegal. I suppose it's assumed that as a business owner, you'll have a lawyer or be careful when signing things, unlike payday loans and such. On a personal level though, it does suck and it is really terrible when you have to work with someone that's trying to undermine you. It's incredibly frustrating.
- ChuckMcM 10y ago
  And he mentions that in the article, he was very naive. The sad truth is that this stuff doesn't get taught well (or conversely its the only good reason for getting an executive MBA where you learn from other executives). One of the random events that can make you a better entrepreneur is to interact with someone who is sociopathic early in your career. To experience the feeling that this person is totally on your side and then experience them ripping you to pieces for their own gain really helps add perspective to your future dealings.
  - danielvf 10y ago
    I agree. Though the cheapest way to get this pricless experience is to play a few game of Diplomacy online.
  - cortesoft 10y ago
    If I were a naive business owner, I sure as hell would hire a lawyer to look at any giant load contract I was signing.
seibelj 10y ago
As a Boston native, I have spoken with multiple people who worked for / knew people who worked for karma loop. It (was?) a company that grew in spite of its culture / founder. Lots of drinking, open drug use, sex in the office, etc. Apparently the parties were wild, though!
- karmakarma1 10y ago
  I am very sympathetic to the founder, and he made a lot of very bad decisions (that he admits) but ultimately, the reputation coming out of karma loop locally was that they were way in over their heads and a dumpster fire. I think this cautionary tale is important and worth reading, but taking on a bad loan wasn't the only issue they faced. The other side of the fence has a private equity company realizing they may have just entered into a world of chaos and taking the steps they felt necessary to protect what capital they could. Not understanding the repercussions of the financial moves you are making on the company's future may be an indication as to the general sloppiness of which the company is conducted.
- mouzogu 10y ago
  You've just slandered an entire company based on third party information. Unless you witnessed it yourself.
  - seibelj 10y ago
    It's also described in various articles about the company, if you want to read more. I post with an account linked to my real life persona and I stand by what I say.
    - mouzogu 10y ago
      I'm not questioning the veracity of the claim but rather the generalisation made of an entire company. For what it's worth an online article is still a third party source just like the friends you mentioned. Surprised that I got voted down so much. All I am saying is that sweeping generalisations based on information one has not witnessed is wrong. Is that so bad?
rdtsc 10y ago
> I had literally liquidated everything (down to my wife’s engagement ring and all my savings, 401k, etc.) and (foolishly) put every penny I could find back into Karmaloop to try to save it - yet they came after me anyway. [...] A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan. Crazy? Not sure about they details but they could have come after him to make sure he doesn't have resources to come after them, even though he already signed the contract. But perhaps the contract was signed as the CEO of the company but not as him personally?
powera 10y ago
I really want to hear the other side of the story here. There's so much unfocused resentment in this article that I think something else is going on. (specifically, the asides about how the Venture firm flies private jets and hates minorities). The whole point of venture debt is that if there is a bankruptcy, they get the whole company. Whether there was tortuous interference (I think that's the right term) or simply weren't willing to lose more money on this company, I don't know. My basic take on the article is really just "man's company fails, he blames the last person to put in money".
- mst 10y ago
  I'm not sure that interpretation flies if the company never missed a payment.
  - powera 10y ago
    Not missing a payment because the CEO is taking on personal debt to invest in the company is not really sustainable, and almost certainly a red flag to investors. Based on the other article I link to, they seem to have been behind on their payments to everyone else as well. And were doing "deep discounts" to keep cash flow high. Clearly a bubble situation in my mind.
  - JackFr 10y ago
    Well, never missed a payment until the bankruptcy filing, at which point Comvest can line up at the courthouse with everyone else.
joshuaheard 10y ago
That was more like a rant than a "cautionary tale". Without any details, it was hard to make anything of that article, other than the author was angry and bitter at banks. As a business litigator, I learned there are 3 sides to every story: one side, the other side, and what really happened.
- gmarx 10y ago
  Exactly. It is entirely plausible to me that this guy got screwed but as written I only made it about halfway through and couldn't even find the lines to read between.
- ChemicalWarfare 10y ago
  From what I've seen in the news, it was just a chain of poor business decisions made by the company when they decided to expand and dumped a bunch of cash into side projects that had to essentially be written off eventually.
- vinceguidry 10y ago
  The author did promise a series of followups explaining in greater detail what happened. I'd wait for those before passing judgment.
JumpCrisscross 10y ago
Breaking down this story as someone naïve to the company and coming from the equity side. > Comvest blocked other capital sources, jacked up fees, interfered wherever possible (among other things, they inserted an incredibly destructive and incompetent full-time advisor, and they simply delayed and dragged when time was of the essence). Lenders are not shareholders. Unless you violated your indenture, they shouldn't have been given the right to "jack up fees" (interest?). They shouldn't have been given veto rights over corporation actions (again, unless Karmaloop was in violation of its indenture). > Comvest came after me personally for $5+ million [guaranty]. Comvest knew I didn't have any money - I had literally liquidated everything Never personally guarantee company loans. (Curious to hear who Karmaloop and the author's counsel were when this was signed.) If you do, maintain (a) insurance or (b) savings to cover the liability. Either way, this could make Comvest's claim a consumer loan, thereby qualifying for regulatory action, e.g. from the Consumer Financial Protection Bureau (CFPB) and/or the author's state banking regulator(s). > A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan If you signed under duress (e.g. without counsel representing you), or believe Comvest did something illegal, you can terminate "for Cause". There are lots of ways to sue or arbitrate around this kind of language. If, on the other hand, you broke your indenture - that's why you hire counsel before signing. In summary, venture debt isn't inherently evil. It is debt, however - lenders should be seen as being separate and distinct from shareholders. Throwing in warrants can increase the pain a lender is willing to take before they drop the axe. That said, this doesn't sound like predatory lending. (Or venture debt; more like private equity). It sounds like Comvest got tired of management barely making payments while threatening Karmaloop's future ability to pay, found Karmaloop in violation of its indenture (or some consulting contract Comvest and Karmaloop may have signed for the "fees"), and decided to see if they could salvage the investment.
- jrochkind1 10y ago
  What's "barely making payments" -- either you make your loan payments (and on time), or you don't, no?
  - powera 10y ago
subpixel 10y ago
Weird coincidence, I was just reading about this story earlier in the week. I'm interested in the scuttlebutt but at the end of the day I think this is a story of an entrepreneur who was fundamentally unprepared for massive success and then made a series of very expensive mistakes (including poor choices w/r/t executives and advisors) that proved deadly to his business.

80 points by ascertain 10y ago

Interesting article. I'm interested in the financial schemes (of the venture lenders) in the upcoming series of articles or any anecdotes from HN members. This article was more introductory than informing...

brudgers 10y ago
The financial model is pretty much straight out of real estate development and private equity. The best up side for the lender is often being able to call the loan and take control of the asset. My anecdotal observations imply that this is pretty common outside Silicon Valley because it's the model the local yokel investors know through experience. The popularization of "startup" as a synonymous with "new business" and the common idea among founders that raising money and pitching investors and getting mentored is the first priority make happy hunting grounds for this type of investor. That's not to say there aren't vultures on Sand Hill Road, but the standard model there tends to have greater alignment of interests between founders and investors.
- karmakarma1 10y ago
  I saw this a lot first hand doing commercial small business real estate. Hard money lenders give someone a loan to start a restaurant, and if it fails to meet the obligations of the loan, they can foreclose on the restaurant and other property or assets the person has signed as collateral. Taking money as a loan with a personal guarantee is always a very high risk situation and should be avoided unless you absolutely have to.

JackFr 10y ago

c.f http://www.complex.com/style/the-rise-and-fall-of-karmaloop http://www.complex.com/style/the-rise-and-fall-of-karmaloop

MichaelGG 10y ago

I'm not quite sure I understand. The owner signed a deal giving the lender the power to place people in the company, and prevent any recourse. > A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan. Crazy? Not to rub salt in, but I think the "make you" wording is telling here. No one made anyone take this loan. This is not crazy; it makes sense that one party might want to protect themselves from lawsuits. What's "crazy" is accepting such a deal, giving them access to the company. In essence, the owner put himself at complete odds with the lender. Indeed, it sounds like the lender had a huge incentive: loan X, if default, gain 2X. No one should have accepted it, but that doesn't mean it should be illegal. I suppose it's assumed that as a business owner, you'll have a lawyer or be careful when signing things, unlike payday loans and such. On a personal level though, it does suck and it is really terrible when you have to work with someone that's trying to undermine you. It's incredibly frustrating.

ChuckMcM 10y ago
And he mentions that in the article, he was very naive. The sad truth is that this stuff doesn't get taught well (or conversely its the only good reason for getting an executive MBA where you learn from other executives). One of the random events that can make you a better entrepreneur is to interact with someone who is sociopathic early in your career. To experience the feeling that this person is totally on your side and then experience them ripping you to pieces for their own gain really helps add perspective to your future dealings.
- danielvf 10y ago
  I agree. Though the cheapest way to get this pricless experience is to play a few game of Diplomacy online.
- cortesoft 10y ago
  If I were a naive business owner, I sure as hell would hire a lawyer to look at any giant load contract I was signing.

seibelj 10y ago

As a Boston native, I have spoken with multiple people who worked for / knew people who worked for karma loop. It (was?) a company that grew in spite of its culture / founder. Lots of drinking, open drug use, sex in the office, etc. Apparently the parties were wild, though!

karmakarma1 10y ago
I am very sympathetic to the founder, and he made a lot of very bad decisions (that he admits) but ultimately, the reputation coming out of karma loop locally was that they were way in over their heads and a dumpster fire. I think this cautionary tale is important and worth reading, but taking on a bad loan wasn't the only issue they faced. The other side of the fence has a private equity company realizing they may have just entered into a world of chaos and taking the steps they felt necessary to protect what capital they could. Not understanding the repercussions of the financial moves you are making on the company's future may be an indication as to the general sloppiness of which the company is conducted.
mouzogu 10y ago
You've just slandered an entire company based on third party information. Unless you witnessed it yourself.
- seibelj 10y ago
  It's also described in various articles about the company, if you want to read more. I post with an account linked to my real life persona and I stand by what I say.
  - mouzogu 10y ago
    I'm not questioning the veracity of the claim but rather the generalisation made of an entire company. For what it's worth an online article is still a third party source just like the friends you mentioned. Surprised that I got voted down so much. All I am saying is that sweeping generalisations based on information one has not witnessed is wrong. Is that so bad?

rdtsc 10y ago

> I had literally liquidated everything (down to my wife’s engagement ring and all my savings, 401k, etc.) and (foolishly) put every penny I could find back into Karmaloop to try to save it - yet they came after me anyway. [...] A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan. Crazy? Not sure about they details but they could have come after him to make sure he doesn't have resources to come after them, even though he already signed the contract. But perhaps the contract was signed as the CEO of the company but not as him personally?

powera 10y ago

I really want to hear the other side of the story here. There's so much unfocused resentment in this article that I think something else is going on. (specifically, the asides about how the Venture firm flies private jets and hates minorities). The whole point of venture debt is that if there is a bankruptcy, they get the whole company. Whether there was tortuous interference (I think that's the right term) or simply weren't willing to lose more money on this company, I don't know. My basic take on the article is really just "man's company fails, he blames the last person to put in money".

mst 10y ago
I'm not sure that interpretation flies if the company never missed a payment.
- powera 10y ago
  Not missing a payment because the CEO is taking on personal debt to invest in the company is not really sustainable, and almost certainly a red flag to investors. Based on the other article I link to, they seem to have been behind on their payments to everyone else as well. And were doing "deep discounts" to keep cash flow high. Clearly a bubble situation in my mind.
- JackFr 10y ago
  Well, never missed a payment until the bankruptcy filing, at which point Comvest can line up at the courthouse with everyone else.

joshuaheard 10y ago

That was more like a rant than a "cautionary tale". Without any details, it was hard to make anything of that article, other than the author was angry and bitter at banks. As a business litigator, I learned there are 3 sides to every story: one side, the other side, and what really happened.

gmarx 10y ago
Exactly. It is entirely plausible to me that this guy got screwed but as written I only made it about halfway through and couldn't even find the lines to read between.
ChemicalWarfare 10y ago
From what I've seen in the news, it was just a chain of poor business decisions made by the company when they decided to expand and dumped a bunch of cash into side projects that had to essentially be written off eventually.
vinceguidry 10y ago
The author did promise a series of followups explaining in greater detail what happened. I'd wait for those before passing judgment.

JumpCrisscross 10y ago

Breaking down this story as someone naïve to the company and coming from the equity side. > Comvest blocked other capital sources, jacked up fees, interfered wherever possible (among other things, they inserted an incredibly destructive and incompetent full-time advisor, and they simply delayed and dragged when time was of the essence). Lenders are not shareholders. Unless you violated your indenture, they shouldn't have been given the right to "jack up fees" (interest?). They shouldn't have been given veto rights over corporation actions (again, unless Karmaloop was in violation of its indenture). > Comvest came after me personally for $5+ million [guaranty]. Comvest knew I didn't have any money - I had literally liquidated everything Never personally guarantee company loans. (Curious to hear who Karmaloop and the author's counsel were when this was signed.) If you do, maintain (a) insurance or (b) savings to cover the liability. Either way, this could make Comvest's claim a consumer loan, thereby qualifying for regulatory action, e.g. from the Consumer Financial Protection Bureau (CFPB) and/or the author's state banking regulator(s). > A bank can legally make you sign a release of any wrongdoing the bank may ever undertake in the future (!!) as a condition of their loan If you signed under duress (e.g. without counsel representing you), or believe Comvest did something illegal, you can terminate "for Cause". There are lots of ways to sue or arbitrate around this kind of language. If, on the other hand, you broke your indenture - that's why you hire counsel before signing. In summary, venture debt isn't inherently evil. It is debt, however - lenders should be seen as being separate and distinct from shareholders. Throwing in warrants can increase the pain a lender is willing to take before they drop the axe. That said, this doesn't sound like predatory lending. (Or venture debt; more like private equity). It sounds like Comvest got tired of management barely making payments while threatening Karmaloop's future ability to pay, found Karmaloop in violation of its indenture (or some consulting contract Comvest and Karmaloop may have signed for the "fees"), and decided to see if they could salvage the investment.

jrochkind1 10y ago
What's "barely making payments" -- either you make your loan payments (and on time), or you don't, no?
- powera 10y ago

subpixel 10y ago

Weird coincidence, I was just reading about this story earlier in the week. I'm interested in the scuttlebutt but at the end of the day I think this is a story of an entrepreneur who was fundamentally unprepared for massive success and then made a series of very expensive mistakes (including poor choices w/r/t executives and advisors) that proved deadly to his business.