4 ms·

Idea: Non-Recourse Founder Loans

10 points by waveid 5y ago

Would you take out a non-recourse (zero liability) loan against some of your shares in exchange for interest + shared upside? For example, if you have $10mm in founder equity, would you take out a $2mm loan against your shares for personal liquidity? If the value of your shares went to $0, you would owe $0. But if you IPO'd and your shares were worth $100mm, you would pay $2mm + interest ($250k?) + 10% shared upside ($1.8mm).

diskzero 5y ago
I might, but are they some other details to this loan? Would there be management or directorial involvement? I am not opposed to receiving input from investors, but am curious about the fine print of a loan like this.
- waveid 5y ago
  No involvement or weird terms. Would probably require that you have raised a Series A+ from a decent VC. The spirit of the loan would be such that if your equity value goes to zero, you owe nothing. If the value of your equity appreciates, you repay the principal, interest, and some of the upside.
timoth3y 5y ago
What you are describing is basically selling a binary call option not a loan. Binary options are fairly popular among retail traders, and are generally sold rather than bought by institutional firms. So it might be hard to find someone to take the other side of that trade. Edit: I'm not saying it's a bad idea. There might be tax reasons to structure this a loan, but looking to binary option pricing might give you a good idea on ow much "interest" you might expect to pay.
- waveid 5y ago
  Agree the spirit of the loan is very “option-like.”
qqqwerty 5y ago
What happens if the equity loses value but doesn't go to zero? Is the principal reduced? And if the price stays flat, is interest still owed? And what triggers a settlement. Would the loan get called back only during a liquidity event (i.e. acquisition or IPO). Or would it get called back at the next funding round or after a certain number of years? This definitely seems like it could be a better deal than selling a small portion of equity to investors. But I also fail to see what the upside is here for you. Seems like you are taking the same risks as equity investors, while severely capping your upside.
- waveid 5y ago
  You would be able to borrow against ~10% of your vested shares. So if your vested shares are worth $10mm, you could borrow up to $1mm. Downside Case A: Your vested equity is worth $10mm and you borrow $1mm, but your total vested equity ends up being worth $500k in a fire sale, you would owe $500k. Downside Case B: Your vested equity is worth $10mm and you borrow $1mm. Your total vested equity ends up being worth $1mm in a fire sale, you would owe $1mm. In any downside case, you would owe no more than what you receive from a liquidity event. There is no scenario where you only make $100k but owe $1mm, for example. There would be no call back clauses, the loan would only be due upon a liquidity event. Upside Case A: Your vested equity is worth $10mm and you borrow $1mm. Your total vested equity ends up being worth $100mm in an IPO, you would owe $1mm + interest ($250k?) + $900k shared upside. Definitely less upside than an equity investment, but there are large institutional investors that want access to the venture capital asset class but can't get access to hot deals. I work in VC and have seen this first hand. This would be a vehicle to give them some exposure to hot companies. Moreover, it could expand into employee equity as well, which increases capacity for capital allocation. I modeled the probable distribution, and in the midpoint scenario, a portfolio of 100 Seed-Series C startups would likely return 10-15% net IRR. That's good enough to attract institutional capital.
  - qqqwerty 5y ago
    k, thanks. So it sounds like the tradeoff that a founder is making between selling a small portion vs taking this loan is that in the case of a down round, they would still get something from their shares. i.e. in the your ~1mm fire sale case, if they sold the equity instead, they would still get ~$800k. That seems like an interesting trade off. More exposure to the upside at the expense of a potential payout in an underwater exit. I suppose in a ZIRP environment, a product like this makes sense, and I know a few folks who might be interested.
phekunde 5y ago
Few years ago I saw some statistics for UK SMEs/Bs(and I think that is true for almost all countries) that showed that within 5 years most small companies wind up. If that is the case then this statement of yours that "If the value of your shares went to $0, you would owe $0." is a serious threat to your business model. If you are betting on few big ticket wins then that could be a very uphill task for you as you do not have any leverage over the companies; if you do then I would like to know how. BTW, how will the interest and the share upside percentage be determined?
- waveid 5y ago
  I would focus on Seed+ startups backed by well-known VCs, so the failure rate would likely be ~50%. I modeled the probable distribution and it looks like I would return ~10-15% net IRR in a midpoint scenario. Interest rate would be LIBOR + some fixed % (probably 5%). Shared upside would be fixed at 10-15%.
dmarlow 5y ago
I think this is a neat idea. There's a big push towards venture debt and this nicely correlates as the equivalent option for early liquidity. Given the right terms, I'm sure both sides would be willing to participate.

10 points by waveid 5y ago

diskzero 5y ago

I might, but are they some other details to this loan? Would there be management or directorial involvement? I am not opposed to receiving input from investors, but am curious about the fine print of a loan like this.

waveid 5y ago
No involvement or weird terms. Would probably require that you have raised a Series A+ from a decent VC. The spirit of the loan would be such that if your equity value goes to zero, you owe nothing. If the value of your equity appreciates, you repay the principal, interest, and some of the upside.

timoth3y 5y ago

What you are describing is basically selling a binary call option not a loan. Binary options are fairly popular among retail traders, and are generally sold rather than bought by institutional firms. So it might be hard to find someone to take the other side of that trade. Edit: I'm not saying it's a bad idea. There might be tax reasons to structure this a loan, but looking to binary option pricing might give you a good idea on ow much "interest" you might expect to pay.

waveid 5y ago
Agree the spirit of the loan is very “option-like.”

qqqwerty 5y ago

What happens if the equity loses value but doesn't go to zero? Is the principal reduced? And if the price stays flat, is interest still owed? And what triggers a settlement. Would the loan get called back only during a liquidity event (i.e. acquisition or IPO). Or would it get called back at the next funding round or after a certain number of years? This definitely seems like it could be a better deal than selling a small portion of equity to investors. But I also fail to see what the upside is here for you. Seems like you are taking the same risks as equity investors, while severely capping your upside.

waveid 5y ago
You would be able to borrow against ~10% of your vested shares. So if your vested shares are worth $10mm, you could borrow up to $1mm. Downside Case A: Your vested equity is worth $10mm and you borrow $1mm, but your total vested equity ends up being worth $500k in a fire sale, you would owe $500k. Downside Case B: Your vested equity is worth $10mm and you borrow $1mm. Your total vested equity ends up being worth $1mm in a fire sale, you would owe $1mm. In any downside case, you would owe no more than what you receive from a liquidity event. There is no scenario where you only make $100k but owe $1mm, for example. There would be no call back clauses, the loan would only be due upon a liquidity event. Upside Case A: Your vested equity is worth $10mm and you borrow $1mm. Your total vested equity ends up being worth $100mm in an IPO, you would owe $1mm + interest ($250k?) + $900k shared upside. Definitely less upside than an equity investment, but there are large institutional investors that want access to the venture capital asset class but can't get access to hot deals. I work in VC and have seen this first hand. This would be a vehicle to give them some exposure to hot companies. Moreover, it could expand into employee equity as well, which increases capacity for capital allocation. I modeled the probable distribution, and in the midpoint scenario, a portfolio of 100 Seed-Series C startups would likely return 10-15% net IRR. That's good enough to attract institutional capital.
- qqqwerty 5y ago
  k, thanks. So it sounds like the tradeoff that a founder is making between selling a small portion vs taking this loan is that in the case of a down round, they would still get something from their shares. i.e. in the your ~1mm fire sale case, if they sold the equity instead, they would still get ~$800k. That seems like an interesting trade off. More exposure to the upside at the expense of a potential payout in an underwater exit. I suppose in a ZIRP environment, a product like this makes sense, and I know a few folks who might be interested.

phekunde 5y ago

Few years ago I saw some statistics for UK SMEs/Bs(and I think that is true for almost all countries) that showed that within 5 years most small companies wind up. If that is the case then this statement of yours that "If the value of your shares went to $0, you would owe $0." is a serious threat to your business model. If you are betting on few big ticket wins then that could be a very uphill task for you as you do not have any leverage over the companies; if you do then I would like to know how. BTW, how will the interest and the share upside percentage be determined?

waveid 5y ago
I would focus on Seed+ startups backed by well-known VCs, so the failure rate would likely be ~50%. I modeled the probable distribution and it looks like I would return ~10-15% net IRR in a midpoint scenario. Interest rate would be LIBOR + some fixed % (probably 5%). Shared upside would be fixed at 10-15%.

dmarlow 5y ago

I think this is a neat idea. There's a big push towards venture debt and this nicely correlates as the equivalent option for early liquidity. Given the right terms, I'm sure both sides would be willing to participate.