4 ms·

Debt financing would be wonderful (note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever

by juped 7y ago

Debt financing would be wonderful (note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever other completely unrelated thing is making you sanctimoniously kneejerk that "debt is bad". Can we please have an informed discussion of debt as a part of a business capital structure?) for software businesses, which have very predictable capex costs. The issue was always that bankers don't want to lend for, basically, cultural reasons. When it actually starts becoming possible and there start being standard diligence scripts, etc., it will be much more favorable than equity financing for basically anyone who can get it.

zozbot234 7y ago
How does debt help deal with "very predictable capex costs"? You would need very predictable revenue to make it work, otherwise equity financing seems like it might be preferable.
- juped 7y ago
  Debt financing generally makes more sense for capex, not opex. Servicing the debt becomes an opex, basically, so it would be weird to finance opex out of it.
wongarsu 7y ago
I don't think it's only cultural, software businesses also have very few assets that could be liquidated. Volkswagen might finance 2/3 of everything it does with debt, but if it just stopped tomorrow and sold all production facilities then lenders would get more than half their money back. If a typical software startup stops operating and sells off all its assets it gets a bit of spare change and the lenders leave with close to nothing.
- martinald 7y ago
  I'm really not sure if that's the case. With some stuff (eg: car fleets) which are pretty liquid they may get a return. But on some super specialised machinery for VW which only makes VW specific parts they are going to really struggle to get any money for it.
  - sokoloff 7y ago
    Industrial machinery is usually more fungible/configurable than that. No one (except the secondary parts makers) has much use for the dies to stamp out Tiguan fenders, but lots of sheet metal fabs (inc other auto makers) can use the stamping presses. It might be 30¢ on the dollar, but that’s likely better than the office chair and laptop that a software startup will leave behind.
    - martinald 7y ago
      Oh totally agree at them getting something for it. Just I doubt they'd get 2/3rds of the value of equipment.
      - ska 7y ago
        The claim was different : that maybe 2/3 of their business activity was financed, and if it was liquidated tomorrow the lender would be able to get “more than half” of that back.
- ec109685 7y ago
  The users paying each month are the assets in this article’s thesis. As long as when a company shuts down, they transition their users to a new entity (since they are valuable reoccurring revenue), the lenders will get paid.
  - sokoloff 7y ago
    Are you imagining a successful company with a large book of users generating a healthy ARR? If that’s the situation, the lenders will get paid, because the business will keep running. The more likely risk to a bond holder is that the company fails to generate a healthy business, pays most of the loan out in salary while trying, and now the lenders own the company which is a couple of two year old laptops and a few thousand per year in ARR that cannot be profitably served.
    - stanleydrew 7y ago
      The essay is explicitly talking about the former. Rather than sell a bunch of dilutive equity at Series B, a company with decent recurring revenue could collateralize that revenue stream and sell it.
      - nemothekid 7y ago
        In what situation would you opt for a dilutive series B where you had enough revenue that a bank would collaterize it for you? If you are profitable, then it’s probably wiser to not take the dilution round. If you aren’t, your revenue is likely worthless as I can’t imagine a bank would have the risk appetite to turn a money losing venture into a profitable one by taking it over
        ec109685 7y ago
        You need the money to scale sales operations to the level of revenue.
        nemothekid 7y ago
- juped 7y ago
  Usually you do a voluntary reorganization between the creditors and the business in the event of default, and a business with steady revenue is often an asset worth owning.
isoskeles 7y ago
What are these cultural reasons that make bankers not want to lend?
- thoughtstheseus 7y ago
  They usually make less money on the deal. It’s also more tedious work in ways (legal). Debt is sterotyped as more boring work on average.
rsync 7y ago
"note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever other completely unrelated thing is making you sanctimoniously kneejerk that "debt is bad". Can we please have an informed discussion of debt as a part of a business capital structure?" I understand your frustration and, largely, agree with it. You are correct that these are two different things and shouldn't be conflated. Until they should be. The two "types" of debt you are drawing a distinction between (or the familiar discussion of national debts vs. household debts, usually in the context of federal spending vs. austerity, etc.) do indeed behave differently under normal circumstances. In extreme cases, however, these heuristics that you find so primitive and annoying are relevant and actionable. Ignore them at your peril.
RookyNumbas 7y ago
Banks don't want to lend to startups because they actually like their loans to be repaid. VCs don't want to lend to startups because you can't make 100x return on debt.

by juped 7y ago

zozbot234 7y ago

How does debt help deal with "very predictable capex costs"? You would need very predictable revenue to make it work, otherwise equity financing seems like it might be preferable.

juped 7y ago
Debt financing generally makes more sense for capex, not opex. Servicing the debt becomes an opex, basically, so it would be weird to finance opex out of it.

wongarsu 7y ago

I don't think it's only cultural, software businesses also have very few assets that could be liquidated. Volkswagen might finance 2/3 of everything it does with debt, but if it just stopped tomorrow and sold all production facilities then lenders would get more than half their money back. If a typical software startup stops operating and sells off all its assets it gets a bit of spare change and the lenders leave with close to nothing.

martinald 7y ago
I'm really not sure if that's the case. With some stuff (eg: car fleets) which are pretty liquid they may get a return. But on some super specialised machinery for VW which only makes VW specific parts they are going to really struggle to get any money for it.
- sokoloff 7y ago
  Industrial machinery is usually more fungible/configurable than that. No one (except the secondary parts makers) has much use for the dies to stamp out Tiguan fenders, but lots of sheet metal fabs (inc other auto makers) can use the stamping presses. It might be 30¢ on the dollar, but that’s likely better than the office chair and laptop that a software startup will leave behind.
  - martinald 7y ago
    Oh totally agree at them getting something for it. Just I doubt they'd get 2/3rds of the value of equipment.
    - ska 7y ago
      The claim was different : that maybe 2/3 of their business activity was financed, and if it was liquidated tomorrow the lender would be able to get “more than half” of that back.
ec109685 7y ago
The users paying each month are the assets in this article’s thesis. As long as when a company shuts down, they transition their users to a new entity (since they are valuable reoccurring revenue), the lenders will get paid.
- sokoloff 7y ago
  Are you imagining a successful company with a large book of users generating a healthy ARR? If that’s the situation, the lenders will get paid, because the business will keep running. The more likely risk to a bond holder is that the company fails to generate a healthy business, pays most of the loan out in salary while trying, and now the lenders own the company which is a couple of two year old laptops and a few thousand per year in ARR that cannot be profitably served.
  - stanleydrew 7y ago
    The essay is explicitly talking about the former. Rather than sell a bunch of dilutive equity at Series B, a company with decent recurring revenue could collateralize that revenue stream and sell it.
    - nemothekid 7y ago
      In what situation would you opt for a dilutive series B where you had enough revenue that a bank would collaterize it for you? If you are profitable, then it’s probably wiser to not take the dilution round. If you aren’t, your revenue is likely worthless as I can’t imagine a bank would have the risk appetite to turn a money losing venture into a profitable one by taking it over
      - ec109685 7y ago
        You need the money to scale sales operations to the level of revenue.
        nemothekid 7y ago
juped 7y ago
Usually you do a voluntary reorganization between the creditors and the business in the event of default, and a business with steady revenue is often an asset worth owning.

isoskeles 7y ago

What are these cultural reasons that make bankers not want to lend?

thoughtstheseus 7y ago
They usually make less money on the deal. It’s also more tedious work in ways (legal). Debt is sterotyped as more boring work on average.

rsync 7y ago

"note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever other completely unrelated thing is making you sanctimoniously kneejerk that "debt is bad". Can we please have an informed discussion of debt as a part of a business capital structure?" I understand your frustration and, largely, agree with it. You are correct that these are two different things and shouldn't be conflated. Until they should be. The two "types" of debt you are drawing a distinction between (or the familiar discussion of national debts vs. household debts, usually in the context of federal spending vs. austerity, etc.) do indeed behave differently under normal circumstances. In extreme cases, however, these heuristics that you find so primitive and annoying are relevant and actionable. Ignore them at your peril.

RookyNumbas 7y ago

Banks don't want to lend to startups because they actually like their loans to be repaid. VCs don't want to lend to startups because you can't make 100x return on debt.