Debt tends to be hard for super new companies, even with orders in hand. If you are developing a new product and don't have cash up front, there's a good chance you never deliver, and both lenders and potential customers know that. Also looks unattractive in future VC rounds, but in this case probably secondary to my first point.
This…not to mention NOLs, contracts, MSAs, etc. At some level there is a market price for these “assets”. Maybe we need an eBay for near bankrupt startups? The bankers aren’t getting it done.
Taking out 7-8 figure loans to exercise start-up options in a private company in a time of decreasing valuations and market uncertainty sounds like a pretty poor idea.
He mentions debt but not security.
Most banks won't finance a pre-revenue company without personal guarantees. And if you end-up borrowing against your own assets, you're basically financing yourself.
Never thought of it that way but makes perfect sense. My view was distorted by the fact that my banker easily opens lines of credit for my company where the collateral is virtually non existent (SaaS startup). I compared that to industrial companies where, to me, assets are more liquid:a truck or whatever industrial equipment probably can probably be sold more easily at an auction than the software IP of a company. While true, I neglected the fact that the auctionned truck will go for probably 25% of its original value and the bank will not refer its funds...
My banker is not trying to earn something on our lines of credits, he is betting on the fact we will do a lucrative exit and that it will, in the end, be beneficial to him.
Not applicable for young web startups. Banks like lending to people and businesses with assets and revenues not ideas. Plus, if you take on debt you it makes it harder to cut and run if your idea doesn't pan out the way you planned.
Banks are for houses and sometimes cars. They might be for restaurants and brick-and-mortar businesses, but I don't think it's a wise idea, since those also fail. They are not for technology startup companies, and not just because they don't want to loan you money.
There are angels who will give you convertible debt at reasonable terms, if they like what you're doing. But, it's probably wise to give up a little equity to get someone with some money savvy working towards your success, and that's one of the benefits of raising money from investors that work with tech startups.
In short: Banks don't want you, and you don't want them. Debt is bad for you.
because no investor wants to take an equity like risk for a limited upside return which debt is. If the company is still early, but doing well, you want the full upside.
"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?
a) The company can always go tits up at any moment without prior warning, however unlikely it appears to be now. A loan will always be riskier for the founders (personal liability) even if they are printing money right now.
b) Investors want a shot at making 10x or 100x, even if that means a lot more risk. Handing a loan is safer, but you only get to make 1.4x at best; that's not the game they want to play.
The real problem is that we don't have a more effective capital model. While there's lots of experiments in funding going on, no-one's really figured out a risk model that works in good times let alone bad.
Fundamentally new businesses fail at a high rate, it's the nature of new businesses. But that means cost of capital is going to be high to cover the cost, but without high-growth it's hard to justify that cost (and that's not even getting into things like fraud which are a big reason new businesses can't get financing)
It's still tough from a liability standpoint as the loan needs to be 100% recourse for tax reasons, so you have to pay it all back even if the company goes under. With high valuations this might be a lot of money. You are therefore investing more in an underversified portfolio increasing an already high startup risk.
If you need a sudden burst of capital, then you can't always wait a few months.
Also, some of the companies who take out these loans (and presumably the ones paying closer to 30%) are not profitable. Their only alternative is selling equity, which obviously comes at great cost.
Right but that's why loans make sense. We know the assets are good quality but it will take time to liquidate them. Companies that can't wait for that to happen will benefit from taking a loan to buy themselves time.
reply