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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

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.

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.