
Should you raise debt or equity? - unfoldedorigami
http://www.venturehacks.com/articles/debt-or-equity
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sethjohn
I was sort of surprised the first time I learned that anyone would give you
financing for debt. Even at a 20% discount rate, it seems like a successful
startup should be increasing their valuation by a lot more than 20% between
rounds.

Conversely, debt seems like a really bad deal for investors. They only get a
20% discount when the company goes into Series A financing, in return for the
risk that the company will go belly up before then and they lose it all.

How does this square with the (admittedly problematic) conventional wisdom
that investors look for a ~10x return on their money and expect ~1/10th of
companies to fail?

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pg
Funding startups with debt is extremely risky, unless it's convertible debt,
which is just a hacked form of equity.

The reason is that a typical loan will be secured by the company's stock. If
you fail to repay it when it's due, your company will be forfeited to the
lender. It's bad to make deals like this in a situation where things can
change so fast. Viaweb was almost destroyed when we couldn't repay a bridge
loan that we'd taken in order to see us through an acquisition that then
didn't happen.

~~~
sethjohn
I believe this article discussed only convertible debt, and only regarding
seed-round funding.

No matter what the situation, though, aren't the investors going to own your
company if you really run out of money? And if your company is doing just
fine, shouldn't it be easy enough to get another loan/investment to keep the
creditors at bay?

~~~
owinebar
This is a good question. The other investors may already be in control of the
company and just attempt replacing the founders with professional management.
They may liquidate, since sunk costs are sunk.

According to Paul's essays, the software of Viaweb was powerful because it was
written in a high-level (but bottom-up) way. It seems like besides this being
an edge over your competitors, it would also make your investors leery of
getting rid of you. Who else would want to buy it if the Viaweb team wasn't
there to walk them through it? And wouldn't that consideration also be true
for lenders? I recall reading something about Trump's period of declining
fortunes years ago - to whom, exactly, were the banks going to sell his gaudy
yacht and other outrageously expensive and virtually unsellable properties?
They were better off pretending he could still be successful for a while, and
they got lucky.

