
U.S. Startups Taking on Debt - kimsk112
https://www.bloomberg.com/news/articles/2016-12-19/u-s-startups-are-piling-on-debt
======
endymi0n
With all due respect to the OP, I think debt is amazing and a great and
sensible solution of financing a company - that VCs want to distract you from
for their own benefit.

If all factors point into the right direction, why would you give VCs a free
ride with a steaming train instead of just going all in yourself and
personally taking on a bank loan? (especially in the way more conservative and
less trigger happy VC environment in Europe)

No doubt it's hard (due to much heavier regulations around bank loans), but
with the right KPIs it's really not much harder than raising a round.

Sociomantic did it. We did it too - and by now financed our own Series B with
revenue.

Way too many people trying to build a startup instead of building a company...

~~~
coldtea
> _why would you give VCs a free ride with a steaming train instead of just
> going all in yourself and personally taking on a bank loan?_

Because most startups fail?

And startups that VCs aren't interested in, even more so?

~~~
andruby
> And startups that VCs aren't interested in, even more so?

Do you have any reference or data to back this claim?

VCs often aren't interested in startups that don't aim to be a billion dollar
business. And those might actually have a better chance of succeeding.

~~~
codelitt
Exactly. DHH quite famously argues this point.

[https://m.signalvnoise.com/reconsider-41adf356857f#.9npvz09a...](https://m.signalvnoise.com/reconsider-41adf356857f#.9npvz09ah)

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TheBiv
I don't know if it's just me, but I feel like a majority of the HN community
seems to lean towards building a sustainable business without the need to take
on outside capital that adds debt to the business. I definitely agree with
that sentiment, however I love a nuanced article like this which doesn't paint
debt as an entirely "bad" thing that needs to be avoided at all costs.

This was an awesome article to read as it balances the risks and possible
advantages that taking on debt can bring a small company.

~~~
BadassFractal
It's great if you can take your time to get bootstrapped and build something
sustainable, but sometimes you're Sidecar and you get Ubered by a company with
seemingly infinite backing and you stand no chance, so you have to accelerate
or be left in the dust by someone much hungrier. Same with businesses such as
Homejoy / Handy where you need to be hugely unprofitable for a while until all
of your competition dies out and then it's a winner-take-all market with you
being the monopoly and reaping all of the benefits. It's a strategy, at the
end of the day.

~~~
danieltillett
Or you can choose a smaller niche where you can't be ubered. The hedonistic
value of money has a very steep downward slope.

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qwrusz
The article is not wrong, but I work in this space so maybe I can add some
context from I have seen:

The author seems a bit hyperbole happy; yes debt volume is up but it's nothing
to foam at the mouth over...Phrases like " _spiked_ in 2016", " _surged_ 19%",
" _doubled last year 's total_" (Wellington did 5 loans last year, so "double"
is only 5 more loans) this language makes "piling on debt" sound bigger than
it really is...

If you look at the growth of startups over the past few years and compare that
to debt volume: then up 19% or doing 5 more debt deals is in line with what
would be expected and maybe even a bit low.

Second point: Without naming names, and without contradicting the article, a
significant portion of debt taken on by startups is mezz debt or bridge loans.
In the cases of bridge loans for example, more mature startups often use
bridge loans prior to an expected IPO. So with the IPO market bottlednecked at
the moment, the increase in debt deals this year is expected as it partly
reflects startups waiting out an upcoming increase in IPOs (hopefully).

Connected to planning for IPOs is in some cases company boards and/or their
VCs will encourage small debt deals to help train CEOs and CFOs for the "big
leagues" after they IPO. New, relatively young, first-time CEOs and CFOs have
no experience managing a complex capital structure of equity and debt. So
boards and VCs encourage getting their feet wet with a bit of debt while still
private. You see BS mini acquisitions by startups for similar reasons. If this
sounds like boards and VCs treating some CEOs/CFOs like children who need
training wheels, that is correct.

Lastly, the article makes it seem like a lot of startups are turning to debt
because VC funding has dried up for them or they want to avoid printing a down
round. This is not entirely accurate. While VC investors' approach might be
generalized as thinking about 'reward before risk', debt lenders looks at
'risk before reward'. SO if a startup is too risky for VC capital, 9 times out
of 10 they are too risky for debt as well. Any startups who think they have
loans as a backup option if they can't raise their next round are in a for a
tough wake up call. The startups that get debt are relatively healthy and will
have both equity or debt as options. Or they just need a small amount of money
and offer recourse assets. Debt is not as attractive as one might think if you
actually do the math side by side and look at the convenants.

~~~
vidarh
> SO if a startup is too risky for VC capital, 9 times out of 10 they are too
> risky for debt as well. Any startups who think they have loans as a backup
> option if they can't raise their next round are in a for a tough wake up
> call.

Reminds me of the one startup we once partnered with that were entirely bank
funded through a major R&D effort. I'm still in awe at the financial
discipline it took them, given that the bank released money in tranches
equivalent to what he needed for 1-2 months at a time, entirely contingent on
meeting extremely narrow performance targets to convince the bank they were on
track and still met the risk profile. Mess up the slightest little bit even
one month, and they'd be totally at the mercy of their bank manager. The bank
saw it as borderline in terms of their risk.

Meanwhile, if they'd gone to a VC with the business in the state it was in,
the VCs would be metaphorically throwing stacks of money at the company.

~~~
rhino369
Traditionally debt has been seen as the cheaper way to capitalize a business.
It's just that start ups are terrible credit risks and had no ability to get
loans. Obviously every situation is unique. The freedom of a lot of money now
might be worth giving up equity, especially in a market where first mover is
so significant.

But if you use debt, all the upside is yours.

I still think debt is better, especially because a lot of equity comes with
with debt-like terms like liquidation preferences. So it's basically the worst
part of debt and equity combined.

------
staticelf
Umm... I donno. I think taking other peoples money in general is a bad thing
due to psychology. It's very easy to spend other peoples money but you always
think one time extra before you spend your own.

Many of these companies that take on huge VC rounds or take a lot of debt seem
to often employ unnecessary many people, hire big unnecessary offices money
that would never have been spent if it was their own money.

Sure I understand if you really need to grow fast, but even then I think many
spend their money on unnecessary crap even when they have zero revenue.

The goal for every company should always be to maximize revenue and minimize
the cost of doing business. People in the startup scene seems to forget that
too often.

~~~
swalsh
> maximize revenue and minimize the cost of doing business

Often doing both at the same time is difficult, and near impossible. To
increase revenue you need a sales staff, and engineering time on building new
features for new markets. Reducing costs requires your engineering staff, and
maybe a business staff to negotiate with suppliers (or whatever your other
inputs are). The engineers are often different kind of people. The type of
engineer who is great at maximizing a process is probably not the same type of
engineer who is good at rapid prototyping, and building something that "just
works".

There's a transition in every startup that reaches a point of maturity where
they start to build processeses, and start to rebuild existing systems. It's
usually at the same time that the founding staff starts to leave.

Startups concentrate on Revenue, and hope they reach the level of worrying
about costs.... and VC money makes that SO MUCH EASIER. Bootstrapping usually
means you limit your input costs, which limits the rate of growth you can
achieve.

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edblarney
The very premise of the article:

"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?

~~~
codelitt
Debt financing is usually massively cheaper than equity financing. If you need
working capital and can pay back loans with decent terms, then you should
almost always prefer debt. I could be wrong, but I get the impression startups
either don't understand how to leverage debt or it's just not sexy. No one
gets a TechCrunch article written about their new 500k loan from Wells Fargo
that they need for working capital. VCs aren't exactly keen on revenue
producing startups going to a bank instead of them either.

Another possibility could be they are no where near to producing the revenue
needed to make payments or pay off a loan and equity has no hard deadline or
immediate revenue requirements. Unfortunately, that's kind of a terrible cycle
as a company with cheap debt and revenue is likely to be built on better
fundamentals than one that has no idea when it will have revenue.

~~~
edblarney
"could be they are no where near to producing the revenue needed to make
payments or pay off a loan a"

\---> Then there is no way they could feasibly get any debt.

That's the odd part of all of this.

~~~
codelitt
Good point. That part doesn't make any sense. I guess what lenders we're doing
before the recession in the housing market didn't make sense either though.

------
timwaagh
I really do not understand why anyone would would want to lend a startup money
these rates (14%). it may sound like a high percentage but...

\- nobody is ultimately responsible for the debt. if the company runs out of
cash, money gone. you cannot go after the people who squandered your cash. 90%
of startups fails early. it's like a slot machine but when you win, you get
14%.

\- a recent strategy for companies is bankruptcy followed by a 'restart'. get
rid of any debt and a lot of employees, keep the rest.

\- take the money and run. the current system would enable unscrupulous ceo's
to direct the money to themselves and let the company crash. a lender would
lose his money.

lending to companies is broken. if you have ever seen a loan fail to repay
itself, you will not make that mistake again. to enable lenders to have a
reasonable guarantee they will see their money back, the system should be
adjusted so that shareholders can be easily held (personally) responsible for
the companies debt.

conclusion: debt is an amazing way to finance a startup, if you can get it.
the last thing seems very doubtful. a lot of these startup lenders are likely
to lose money.

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saretired
I'm confused. The CEO of Persado is quoted as saying "interest rates are low,"
while the article says that Metamarkets is paying 14% on a loan cut in Oct--
for comparison, the Merrill Triple-C-Rated index ("extremely speculative" junk
bonds) is under 12%. So while it's true that UST base rates are low, that
doesn't seem to be a factor in this funding. Sounds like a story about a few
banks goosing earnings with risky loans and company insiders/VCs getting more
upside "if things work out" and far less of those pesky loses if they don't,
very much like the speculative real estate development loans in the 80s that
made for a big but very short party.

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DelaneyM
I wonder how much the emergence of fintech is affecting this trend?

Debt is a powerful, but often fairly complex, financial instrument. Much like
venture capital. The difference is that most folks in the financial industry
are intimately familiar with debt but relatively unfamiliar with venture
capital; or worse, to those coming from a PE background VC can often appear
completely insane.

The growth of fintech has indirectly added a whole cohort of founders and
entrepreneurs who are much more likely to know how to work with debt and be
able to use it in tandem (or in place of) venture capital.

------
known
Last year venture capitalists plowed a record $79 billion into startups at
often unsustainable valuations

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sandworm101
>>Unlike venture investors who typically bet one investment will hit big and
compensate for duds, lenders get no upside if a startup succeeds.

Obviously not written by a lender. There are countless schemes for lending
money. These are custom contracts, not credit cards. At the simplest, a lender
can delay repayment for a period of years in full knowledge that the business
may fail between now and then. The startup accepts an otherwise ridiculous
interest rate. Or a hybrid approach can be made whereby the later debt can be
settled with stock, stock valuated when the debt is due. Maybe the stock takes
off and repayment is easy, or maybe the stock tanks and the lender takes
substantial ownership of the company. The deal still begins life as a loan.

Lending money to a business and buying a shares in that business are not
mutually exclusive concepts. There is an entire range of schemes available
between those two options.

~~~
saretired
The article specifically mentions commercial bank lenders, which are
regulated. While I'm sure there are non-bank lenders in this space, a
commercial bank can't delay repayment without a charge to the loan-loss
reserve, and taking stock in lieu of payment, unless the stock is good as
cash, is also a loan impairment. Unregulated commercial lenders have more
freedom, but they are also constrained by GAAP.

~~~
wbl
So they take a hit on the loan value which their funders might expect give tge
returns they aim to produce.

Junk bonds are nothing new.

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FloNeu
Seems like the bubble is finally shrinking... i think dept can actually help
an early company focus their effort - if you know you have to produce value,
to meet your next payments - instead of 'oh, yeah i got a billion dollars -
lets buy some art for the office'. I am always amazed when i read articles on
how much money a (typical) unicorn (actually) looses... Granted it can take
some money to build a user-base etc. But, woo... i would love if someone could
calculate the cost of customer for some big ones... Or tell me how shit,
without a business-model, gets founding millions high.

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h4nkoslo
Debt in the limit is the same as equity, from the perspective of investors.
You end up betting fundamentally on the solvency of the business rather than
how much of a (positive) return they will generate.

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swingbridge
Reasonably priced debt is issued with the expectation that most recipients
will succeed and access to it is generally limited to entities with a stable
business model already.

VC money is mostly issued with the expectation that most recipients will fail
and it's priced accordingly.

A strongly performing 'real' company (i.e. one with a strong profit stream)
will nearly always prefer debt to VC money in the same way a strongly
performing public company will issue bonds over selling more shares--the later
tending to be for companies in trouble.

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samfisher83
From a finance perspective debt financing should be cheaper than equity
financing. Sin e equity is more risky it requires a greater rate or return.

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gumby
Amazon famously took on a lot of debt to avoid equity dilution, but I think
this was only after they had gone public.

Of course Bezos left Wall Street to found Amazon so he already had wider
connections that gave him more flexibility in financing.

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Cacti
Wow. 14% is really damn high.

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brilliantcode
This article confirms that the low interest capital days are coming to an end.
Porsche too thought they could grow with debt. Then the low interest capital
ran out and they got bought by Volkswagen.

~~~
SEJeff
I think you're grossly under represending the porsche thing. Porsche did a
very very well executed short squeeze on VW and very nearly succeeded in
acquiring VW.

Look it up. It was a very ballsy move. Even by failing, it still went down in
history as a pretty masterful move. It also caused Germany to change their
accounting laws around things such as that. In the US an equivalent move would
be illegal. The US learned from Short Squeezes when the NY City Council tried
to punish Cornelius Vanderbilt and he exacted revenge on them.

------
known
Not bad [http://www.usdebtclock.org/world-debt-
clock.html](http://www.usdebtclock.org/world-debt-clock.html)

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thedogeye
I've been saying for years that anyone who believes silicon valley is in a
bubble needs to put their money where their mouth is and short SVB stock.

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sb057
Is this a bubble, and if so, when will it pop?

~~~
amorphid
Sometimes debt is cheaper than VC money, if you have the cash flow to pay it
back. If sales tank, and your cash flow slows down, you'll learn how quickly
debt is not always cheaper :) In the article, the first company mentioned
talks about how sales doubled in a year. Well, and an anything that grows that
fast can shrink that fast, too. VC money can have really favorable payment
terms for a company that needs to keep cash within the company to grow.

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micaksica
> "Folks don't want to do down rounds or flat rounds," says Haim Zaltzman, a
> partner at law firm Latham & Watkins LLP, which has handled well over 100
> such loan transactions so far this year. "Debt allows you to get around
> that."

Eh. I'm not too into the whole startup scene these days, and I haven't been
exactly fishing for VC deals in today's market, but I believe that if your
startup is only getting term sheets that provide you with a deal that forces
you down or flat, you should seriously be considering looking at your business
fundamentals before you are trying to raise funding by other means.

VC is speculative and looks for returns with dilution; if your company starts
to go belly up, you can look at some acquihire or insta-acquisition through
the VC's network so the VC firm can save face and see some ROI.

However, if you can't make your debt payments, banks don't care. They have no
LPs to answer to, just their balance sheets. They will gladly step in with
their attorneys and carve out any asset they can from your precious company.
Caveat emptor. I have always been told by trusted GPs that debt is useful in
very, very limited situations, and it seemed to me that the dreams of the
entrepreneurs getting stuck with debt deals are already grasping at straws. I
think there's a point at which you need to know when to quit.

~~~
drewrv
If your company starts to go belly up and you get acquihired, you'll probably
walk away as empty handed as a bank default, due to liquidation preferences
and other terms in VC funding.

~~~
lambdasquirrel
Founders aren't always in it just for the bank account. Between going belly up
and shuttering, and going belly up and giving their team a chance in another
company, existing customers, etc., acquihire is preferable to getting carved
up. At the very least, founders need to save face too.

------
EGreg
Really? Like convertible notes?

~~~
teej
The author is contrasting "venture deals" against "borrowing capital" so I'm
pretty sure they mean conventional loans with banks.

EDIT: The author is totally talking about venture debt and buried the lede. So
yes, convertible notes as far as I can tell. Very misleading.

~~~
mikeyouse
Venture debt is very different to convertible notes. Venture debt usually
involves warrants and preferred shares, they'll take IP as collateral, and are
only offered from a few banks and other financial institutions. They often
have defined interest payments as well.

We had a $X million dollar venture note from SVB at a previous company that
needed to raise cash, it was helpful to keep the company afloat but definitely
came with some pretty onerous terms (as to be expected). It was much different
to the convertible notes that started the company.

[https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_...](https://www.svb.com/Blogs/Derek_Ridgley/Extend_your_startup_s_runway__How_venture_debt_works/)

~~~
teej
Part of the issue is that the author goes through no effort to actually
explain WTF they are talking about, while making it sound like these startups
are raising capital with no equity on the line.

~~~
Animats
Uber actually is. They've been taking on straight debt.[1]

[1]
[https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-s-...](https://www.bloomberg.com/gadfly/articles/2016-06-15/uber-
s-debt-fueled-cheap-price-race-is-on-borrowed-time)

~~~
bbcbasic
Wow! Uber is quite the domino :-)

