

Ask HN: Why are VCs needed? - tech6

My father worked in a bank and one of the main tasks of commercial banking was to give loans to start businesses. The entrepreneur has full ownership of the company and loan was repaid at normal interest rate. Why dont tech companies use this method and why do  they need VC funding instead. If the entrepreneur is confident of his revenue model why not get a bank loan and start his company
======
patio11
_Why dont tech companies use this method and why do they need VC funding
instead._

Because they need more money than banks are willing to lend, their present
circumstances do not imply collateral/predictable revenues/etc which would
justify an underwriting decision to lend more, and their implied failure rates
would make lending at commercially acceptable interest rates a prohibitively
expensive proposition for the bank.

For example, take stock of two guys in their mid-twenties with $30k of their
$40k combined net worth tied into a business. The business has proven revenues
of $10k. They seek $2 million in capital to expand to their next milestone.
_No bank in its right mind_ will loan them $2 million -- they're literally
incapable of making the interest payments on it, to say nothing of predictably
paying it back. By comparison, a VC firm might assign a notional value to
their business of $3 million (the bank would say "It's, literally, worthless:
liquidation costs swamp accumulated value of capital."), put in $2 million and
own 40% of the company, and see 10 similarly situated investments _fail
totally_ to sell this one company for $200 million 5 years from now.

~~~
rmc
_and see 10 similarly situated investments fail totally to sell this one
company for $200 million 5 years from now._

That's the important point. Lots of VCs aren't really investing in a company,
but are aiming to have invested in the next Google or other large tech
company. They are playing blackjack.

~~~
tptacek
Practically all VC invests this way; it's the model.

------
pg
Startups have no collateral.

------
pwim
The goal of a bank is to minimize risk, as they have a capped return. On the
other hand, the goal of a VC is to maximize return, as their is no cap on the
return. The business models are different, and both have their places.

------
flexxaeon
A VC is your business partner. If you fail, they fail as well right along with
you to the tune of their money.

A bank is not your business partner. If you fail via a bank loan, the bank
still wants their money AND interest.

~~~
csense
> If you fail via a bank loan, the bank still wants their money AND interest.

If your business goes bankrupt, the bank only gets their money if they
required you to personally cosign for the loan. Of course, if your business
isn't profitable yet, it's likely that they'll make you do exactly that, as a
condition of getting the loan in the first place -- especially for tech
companies that don't have many assets that can be liquidated in case of
failure.

~~~
flexxaeon
True but bankruptcy would be the step after failure. They _want_ their money
but doesn't mean they will get it back.

~~~
S4M
For a tech company, common sense would require to make the founders liable to
the debt, otherwise they can pay themselves a good salary -with the money
borrowed to the bank - and then bankrupt the company.

For this reason - as well as other reason people here already mentionned - the
banks won't lend so much money to a young tech company.

------
codegeek
"Why dont tech companies use this method and why do they need VC funding
instead"

Banks do not have as much vested interest in a startup as VCs. So their risk
appetite is much lower than VCs. VCs lend money based on future potential of
making it big and they take a lot more risk than a usual lender/bank.

Thats just the money part. VCs always provide a network of connections and key
contact (mostly) who can also help your startup. Good VCs will provide
mentorship and valuable help.

------
eskimoroll
VCs are needed as an asset class because there is a market opportunity to
service a small segment of the population that are trying to create high risk,
capital light, and high growth potential businesses that do not fit the
risk/collateral/historical cash flow characteristics that banks need to
believe that you can service their debt. VC money is EXTREMELY expensive and
can be thought about as similar to credit card debt and payday lending. Sure,
VCs have value added services like contacts and expertise that help portfolio
companies potentially have a higher chance of success, but their primary
motivation to help you is to return money to their limited partners (and
themselves through management fees and carried interest). I'm an entrepreneur
and know many amazing VCs who hopefully will someday fund my business but I'm
realistic in acknowledging the nature of the relationship.

------
johnrgrace
The first rule of banking is you HAVE to get your principle back. I worked at
Capital One and with 30% and fee's for everything you can lose money, key is
getting paid back. Banks will loan money for working capital, if your startup
needs a lot of working capital to finance inventories etc. banking might work.

------
soneill
A good VC brings more than money; they bring expertise and experience. They
have networks and connections that you probably don't. If you really want to
grow, VCs can give you the kind of resources and expertise to actually do
that...a bank can only give you money.

------
MojoJolo
A VC can also offer mentorship, provide some advice, and one of the most
important thing is connections. They can introduce you to another VC or
investor that might boost up your startup.

