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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

by 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.
- qwrusz 10y ago
  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).
vidarh 10y ago
> 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.
- rhino369 10y ago
  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.

by qwrusz 10y ago

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.

qwrusz 10y ago
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).

vidarh 10y ago

> 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.

rhino369 10y ago
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.