9 ms·

U.S. Startups Taking on Debt

137 points by kimsk112 10y ago

sb057 10y ago
Is this a bubble, and if so, when will it pop?
- amorphid 10y ago
  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.
TheBiv 10y ago
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.
- automatwon 10y ago
  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.
  - AtheistOfFail 10y ago
    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.
- enjo 10y ago
  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.
  - jowiar 10y ago
    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.
- ChuckMcM 10y ago
  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.
- BadassFractal 10y ago
  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.
  - danieltillett 10y ago
    Or you can choose a smaller niche where you can't be ubered. The hedonistic value of money has a very steep downward slope.
EGreg 10y ago
Really? Like convertible notes?
- teej 10y ago
  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.
  - mikeyouse 10y ago
    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_s_runway__How_venture_debt_works/ https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_...
    - teej 10y ago
      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.
      - Animats 10y ago
        Uber actually is. They've been taking on straight debt.[1] [1] https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-debt-fueled-cheap-price-race-is-on-borrowed-time https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-...
micaksica 10y ago
> "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.
- elastic_church 10y ago
  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.
- drewrv 10y ago
  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.
  - jfornear 10y ago
    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.
  - 10y ago
h4nkoslo 10y ago
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.
Cacti 10y ago
Wow. 14% is really damn high.
DelaneyM 10y ago
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.
known 10y ago
Last year venture capitalists plowed a record $79 billion into startups at often unsustainable valuations
saretired 10y ago
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.
edblarney 10y ago
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?
- codelitt 10y ago
  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.
  - edblarney 10y ago
    "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.
    - 10y ago
sandworm101 10y ago
>>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.
- saretired 10y ago
  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.
  - wbl 10y ago
    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.
qwrusz 10y ago
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.
- ec109685 10y ago
  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.
samfisher83 10y ago
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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endymi0n 10y ago
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...
- coldtea 10y ago
  >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?
  - rdlecler1 10y ago
    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.
  - ceejay 10y ago
    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.
FloNeu 10y ago
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.
staticelf 10y ago
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.
- deleted 10y ago
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- hx87 10y ago
  > 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.
- swalsh 10y ago
  > 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.
known 10y ago
Not bad http://www.usdebtclock.org/world-debt-clock.html http://www.usdebtclock.org/world-debt-clock.html
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swingbridge 10y ago
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.
timwaagh 10y ago
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.
brilliantcode 10y ago
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.
- SEJeff 10y ago
  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.
gumby 10y ago
Amazon famously took on a lot of debt to avoid equity dilution, but I think this was only after they had gone public. Of course Bezos left Wall Street to found Amazon so he already had wider connections that gave him more flexibility in financing.
thedogeye 10y ago
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.

137 points by kimsk112 10y ago

sb057 10y ago

Is this a bubble, and if so, when will it pop?

amorphid 10y ago
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.

TheBiv 10y ago

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.

automatwon 10y ago
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.
- AtheistOfFail 10y ago
  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.
enjo 10y ago
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.
- jowiar 10y ago
  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.
ChuckMcM 10y ago
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.
BadassFractal 10y ago
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.
- danieltillett 10y ago
  Or you can choose a smaller niche where you can't be ubered. The hedonistic value of money has a very steep downward slope.

EGreg 10y ago

Really? Like convertible notes?

teej 10y ago
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.
- mikeyouse 10y ago
  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_s_runway__How_venture_debt_works/ https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_...
  - teej 10y ago
    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.
    - Animats 10y ago
      Uber actually is. They've been taking on straight debt.[1] [1] https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-debt-fueled-cheap-price-race-is-on-borrowed-time https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-...

micaksica 10y ago

> "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.

elastic_church 10y ago
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.
drewrv 10y ago
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.
- jfornear 10y ago
  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.
- 10y ago

h4nkoslo 10y ago

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.

Cacti 10y ago

Wow. 14% is really damn high.

DelaneyM 10y ago

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.

known 10y ago

Last year venture capitalists plowed a record $79 billion into startups at often unsustainable valuations

saretired 10y ago

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.

edblarney 10y ago

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?

codelitt 10y ago
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.
- edblarney 10y ago
  "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.
  - 10y ago

sandworm101 10y ago

>>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.

saretired 10y ago
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.
- wbl 10y ago
  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.

qwrusz 10y ago

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.

ec109685 10y ago
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.

samfisher83 10y ago

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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endymi0n 10y ago

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...

coldtea 10y ago
>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?
- rdlecler1 10y ago
  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.
- ceejay 10y ago
  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.

FloNeu 10y ago

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.

staticelf 10y ago

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.

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hx87 10y ago
> 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.
swalsh 10y ago
> 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.

known 10y ago

Not bad http://www.usdebtclock.org/world-debt-clock.html http://www.usdebtclock.org/world-debt-clock.html

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swingbridge 10y ago

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.

timwaagh 10y ago

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.

brilliantcode 10y ago

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.

SEJeff 10y ago
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.

gumby 10y ago

Amazon famously took on a lot of debt to avoid equity dilution, but I think this was only after they had gone public. Of course Bezos left Wall Street to found Amazon so he already had wider connections that gave him more flexibility in financing.

thedogeye 10y ago

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.