Debt is dumb. The childish glee coming from this author should be ignored. 2008 is coming again soon and debt holders will suffer. Please get/keep your financial house in order. Business debt is just as dangerous as personal debt.
Debt is a very useful tool for raising capital. It is a way to raise money without selling ownership, and is often the wiser choice. It all depends on the situation. Blanket statements disparaging (or encouraging) debt without regards to the situation are dumb.
When you say, "Debt is dumb" are you speaking in hyperbole? There are lots of examples where debt is not dumb and is in fact the prudent thing to do. If you aren't speaking in hyperbole you are wrong and if you are I suggest that in this case you shouldn't.
Your overall point appears to be that a repeat of 2008 is immanent and this point can be better made without the "Debt is dumb" first sentence.
It certainly was hyperbole. There are obvious situations where debt is not dumb. We live in a time where the vast majority of debt is not used for those obvious critical situations.
How do you propose solving problems like "buy a house" and "buy a car" without debt? The average person who needs to drive to work has no way to buy a car in cash, at least not early on. If you drop all your savings on a new car and suddenly end up with a hospital bill, that car isn't going to pay for it.
I say this as someone who had enough saved to buy a car in cash: Buying it via a loan was the right choice. It boosted my credit rating and more importantly when emergencies came up I had that cash on hand.
Look up the word "savings". It is possible to rent a cheap apartment, buy a used car, and wait until you can afford better things. Obviously some people are going to run into financial difficulties if they have unexpected extraordinary bills. The vast majority of things in life are however, expected. Nothing is new under the sun. The overwhelming debt of the world increases costs. Additionally, debt temporarily tricks most people into thinking they have more than they actually do. I think more people would be interested in working harder for better jobs or opportunities if it wasn't so easy to get whatever you want by signing a piece of paper.
How do I rent a cheap apartment and buy a used car without a job? The job I need a car to drive to? What am I supposed to save, exactly? The allowance I get from my presumably rich parents?
In my case, my first job (at 14) required getting a ride to from a coworker with a car. Getting to university for my job working in the computer lab + my courses required either a car ride from a neighbor or 3 hours on the bus. After I moved away for my first salaried job, I needed a loan (thankfully a personal one and not from a bank - both of which are things many people don't have access to!) to cover my first month of expenses so I could move and actually start getting paid and building measurable savings, since the move already exhausted the savings I had left over after uni.
Money doesn't come out of thin air. Not everyone starts their working life with access to enough money to just buy a car (even used!) and rent an apartment.
>How do I rent a cheap apartment and buy a used car >without a job?...
You answered your question with the second paragraph...?
>In my case, my first job (at 14) required getting a ride to from a coworker with a car...
You chose to go to university in lieu of financial stability. That is how savings is not acquired. Save the money, then go to school. Buy things you can afford, including school.
>Money doesn't come out of thin air. Not everyone starts their working life with access to enough money to just buy a car (even used!) and rent an apartment.
Babies are born without jobs or means to clothe and shelter themselves, but we have what are called families, communities, and society. Each melds together to form a fabric of civilization that provides in one way or another the necessities of life. Start working as young as possible, save up, spend thrift.
Important for what? Your home is not and should no be an investment. Investments come with risks. Don't risk losing your means of shelter because you wanted to make money. Compounding gains with loans for real estate investment as a business does make leverage seem important. That is, until a scenario where real estate prices fall, you cannot acquire more property because you leverage based on property price, loans pay your expenses, and you lose your investments. Pay with cash and renters pay your expenses.
I have no idea why people __LOVE__ making these statements. 2008 was something that affected mostly the US and while it affected the rest of the world to a certain degree, overall very little changed.
Before jumping on my throat, hear me out: There have been several significant financial events since then: the European debt crisis, then Portugal(which is relatively small on a global scale), same with Ukraine and Venezuela, Russia(still going 5 years later), Brazil and those are just off the top of my head. What I'm trying to say is that financial crisis occur almost every year. Keeping your finances tidy is a good life advise but prophecies shouldn't be the motivation for it.
>>I have no idea why people __LOVE__ making these statements. 2008 was something that affected mostly the US and while it affected the rest of the world to a certain degree, overall very little changed.
US is back on top. How's Italy, Greece, Spain etc doing?
I dont know why this is downvoted - the EU implemented austerity and it took a gigantic chunk out of its economy in the last ten years - why is this controversial?
Spain's growth rate has been what, 0%?
Greece is totally screwed, and there's a strong set of evidence to say Brexit was a direct result of the 2008 crisis (because they pushed back so hard on austerity.)
A lot of people cared about Democracy and the ability to hold the politicians we elected accountable for the decisions that were made. Mass immigration was important, but it wasn't the only factor.
Greece is a very different animal altogether and I struggle to see how it will ever recover. I've been to Greece and I'm sorry to say but the same problems are obvious at every step of the socioeconomic ladder.
Italy and Spain are recovering - new businesses are emerging, unemployment in Spain is down by 12% from 26%, Italy is at ~9.5% unemployment.
Comparing several small countries to the US is completely pointless given the difference in population, area, industry , resources and so on...
I'm equally perplexed as to why people always seem to think a big downturn is right around the corner. Maybe there are always enough warning signs that someone with a sufficient penchant for confirmation bias will latch on to.
Regardless, nobody can tell the future - there are simply too many unknowns to consider. We will certainly have more good times and bad times. As to when they come, predict all you want, but historically analyst predictions have an awful track record (historically, expert predictions are wrong most of the time https://www.cxoadvisory.com/gurus/ ). The occasional person who guessed right previously (there will always be some) are then raised up as oracles.
My point exactly. A broken watch is right twice a day. Let's assume that we are all in a simulation. A statement such as "the entity that created the simulation will pull the plug in what we perceive as two minutes". Well yeah, sure... Is it a valid statement? Yes. Is it accurate? Hell if I know.
In a nutshell, Austrian economics. Central banks have made money ridiculously cheap for over a decade, and this leads to malinvestment: investors pour this cheap money into projects that probably yield negative real returns, because there is way more money floating around than viable projects to spend it on. Spend capital on negative-yielding projects for long enough and you erode the productive capacity of the economy until a crisis hits.
That’s the story; hard to say how well it describes reality but there’s surely a modicum of truth in there at least.
Time and date may not be predictable, but the simple math behind the modern monetary system of central banks is quite clear. Print or die. Inflation or recession. When the F.R.B. of the USA stops printing the market crashes. You can watch it happen if you are watching what they do. Since they are now wholly locked in a corner they only have the two options. Inflation or depression. Soon they will purchase stocks outright. We may not actually see a 2008 type scenario, but I'm not going to bet my house, car, and business on it. If we all saved and did not borrow, they could not print.
If time and date are unpredictable, what's the use? Suppose you switch to conservative investments now -- say, bonds. You're going to be hit less hard by the recession, but you also will have missed out on gains.
So, unless you believe you can time the market, it doesn't appear like there is much to do except to make sure you have a rainy day fund.
Your sentiments contribute to the bubble. It is possible to live without forking your money over to the stock market. It is harder to grow great wealth, but that is phony wealth at the moment or soon enough. If everyone invested in themselves, demanded a stable gold or gold backed currency, and eschewed the bubble gains in the markets, the gains would not be there and the manipulation would not be possible. That would reflect the reality of our current situation. Times will get tougher the longer we wait to see reality.
> while it affected the rest of the world to a certain degree, overall very little changed.
This only makes sense if you are making a sharp distinction between the 2008 US crisis and the European debt crisis, which is probably not what the parent meant. That's why people would strongly disagree with you.
Debt can be useful to quickly get capital to grow a business. The problem is that everyone is competing to grow their business faster and so the amount of debt steadily climbs faster and faster than being able to pay the interest. New businesses who gather debt in a more controlled way will look like they aren't growing as fast (if loans were the primary source of funding) and they are quickly left for the companies that grow fast. Luckily, VCs take responsibility with their investments and make it possible for a new business to not need to go into crazy amounts of debt.
Eventually, so much debt will be accumulated that companies will not be able to pay off the interest and the bubble pops. If everyone is always in debt, there will always be a periodic crash.
Aside from the other conclusions and assertions in this long article, this particular bit resonates with me:
"Here is a widely believed cause-and-effect relationship I bet you’ve never thought to invert before: because most startups fail, therefore equity is the best way to finance them. Have you ever considered: because equity is how we finance startups, therefore most startups fail?"
At the very least, this lines up perfectly with my startup experiences and many other case studies I've seen - investors simply are not willing to accept reasonable growth or reasonable returns, they want massive scaling and massive growth. Sometimes that approach works out but very often you get expensive bets that never deliver on the level they need to and the startup flames out or ends up stuck constantly trying to clean up the mess left by the last big bet while trying to execute on a new one. A revolving door of new executives and new business strategies.
Meh, straight debt (not convertible) isn't available to risky startups.
The venture debt industry depends on tight relationships with VCs to ensure reasonable repayment rates. In some cases they reduce risk by reselling part of the debt. In all cases, they're themselves leveraged, lending money from limited partners and not just themselves.
Debt is like medicine: useful to cure certain conditions but nothing to be burdened with your entire life. Once the condition is cured the medicine is no longer needed.
It is also like medicine in that it has a tendency of ending up being worse than the condition it was meant to cure when taken irresponsibly or in too large a dose.
There's another way in which debt resembles medicine: those who sell it are wont to sell it as widely and at as high a price as possible, no matter whether it is the right medicine for the condition at hand.
When used responsibly debt can be a net positive. When allowed to run amok it is a burden upon society. Maybe debt, like medicine, should only be allowed to be taken with a prescription?
I agree with everything except the last line (and I suspect that’s where your downvotes are coming from).
The CEO/CFO should have the freedom to self-prescribe, IMO. In that regard, debt might be more like food. Some businesses have a chronic need for debt and can live quite fine with a lifetime of healthy debt usage.
I don't love this analogy because a healthy person doesn't need medicine. If you can make something for $1 and sell for $2, it's very healthy for a business to take on debt in order to make more of those things. Which is why debt is a normal part of many healthy businesses.
> Maybe debt, like medicine, should only be allowed to be taken with a prescription?
Isn't it though, really?
The bankers determine your "need" and price it according to the risk of you defaulting -- which would seem to put a kink in TFA's argument since most startups fail, the interest rate would be astronomical if true risks were priced in.
Bankers both 'prescribe' as well as sell debt, this is - in theory, at least - different from medicine where the prescriber is not related to the seller.
Why does debt need to be paid off? There’s nothing wrong with running debt forever and never paying it off. Debt, and other stuff like selling options or shorting or futures, is just a way to obtain more money than you have (leverage). If you can use that money efficiently while managing your risk there’s no problem. Without leverage, many business opportunities simply cannot be exploited, such as retail and investment banking. Capital reserve requirements make it impossible to lever up forever, but even so, these institutions are running at like 20x leverage. In particular, quantitative funds like RenTec or AQR could not exist without leverage since the unlevered returns of their strategies are much too low to be attracrive. In its essence, debt promotes the efficient exploitation of market mispricing and business opportunities.
Moreover, it often makes sense to not pay down debt even if you can afford it. Like if I can get a fixed 30yr 3.5% mortgage, why would I even want to pay it off? I can do a ton of different things to make more than a 3.5% return per year. Of course, I’ll have exposure to some risk, but that’s not necessarily a bad thing.
Looking at places like Japan who eschew debt as much as possible, the affects are not positive. Businesses are moribound and hampered by their irrational aversion to debt.
Mathematically, debt scales future expected return and risk by the same amount. Without debt, investors wouldn’t be able to implement their risk preferences, which surely would make the economy worse for everyone, especially those with little capital.
When did the discussion about “financing structure” become a discussion on ethics? Or are you already taking the “bullshit business hockeystick promises” as a “given in the industry”?
Why are fraudulent business practices the first thing that come to your mind?
If you told me about WACC and how equity is like actually really expensive way of financing: ok, I get it, some cool discussion on a provocative questionmark.
Equity is the most expensive financing - especially for startups.
The opportunity costs for funding a “high risk of failure startup” that even just has your money sitting on a bank account is fairly high. When S&P500 markets return 20% p.a. - I’d wanna see 100+% return p.a. on my risky startup (it is of course less of a normal distribution kind of thing, more a “lose many and maybe win one”).
So actually due to inflation and the opportunity costs associated with the risks you have - stuff may or may not depreciate unknowingly.
Watches are only gonna be worth what a seller gives you when the need of selling it arises. Correlation breakdown between asset classes etc etc has made many people not so happy about the decisions they made with more exotic investments and the believe that “not everything depreciates”.
A more fundamental and underlying problem may be: we print too much money and inflation is probably hitting insane levels but “hidden well beneath the improvements in society’s productivity”.
In a Knightean’s risk sense, we may actually be constantly facing “uncertainty” but believe we are dealing with a more predictable concept of “risk” in our lives. Taleb has written a few good books on it.
Guys, take an Accounting 101 class before starting to downvote my questionmark.
I’ll take your equity any time. Your debt not so much.
Burning through other people’s cash on false promises IS NOT the same as having a more equity heavy financing. Either you fund your companies operations through equity or you fund it through debt. So how on earth are you going to fund a company if you don’t want to do equity or debt?
I’m an equity guy. Funded all my shit with my own money and enjoyed the upside. So you’ll get an exclamation mark you can downvote in addition in this post:
No - equity doesn't require servicing. Plenty of businesses have collapsed despite having positive margin and operating cash flow, but outstanding debt. It's almost a feature of the "private equity looting" model that killed Toys R Us and Maplin, among others.
Don't forget about the dividends / interest usually associated with preferred shares. Those are constantly accruing and need to be paid out before any "gains" make their way to common shareholders.
Yeah true, I guess it wouldn't be a question of $.50 on the dollar vs nothing. Maybe extending the repayment period so that payments are lower but it increases the total financing costs?
It just seems to me that if a company is doing something profitably, that would be the company I would want to lend money to.
Or get your money out now in the first tranche and do something less risky with it? It’s not just the face they are profitable, it’s opportunity cost and risk also. If pulling out now screws everyone else involved,it’s not really their problem is it?
yes, but some of the posters here are being purposefully disingenuous.
When getting a mortgage, one of the things the companies will look at is your income to debt ratio. For a company it's no different. Yes, there have been companies that have gone under for too much debt. There have also been plenty of companies that have done well even with debt.
When you hear people say "OPM", aka "Other People's Money", what they typically mean is taking on debt and paying it down over time.
And for the poster who stated you don't have to service equity... that's completely bullcrap. We've all heard stories of VC's shuttering a profitable company because they weren't profitable ENOUGH. There's a cost to everything, that equity isn't free.
General Motors. Several airlines. You’re describing bankruptcy protection. It means the debt holders will agree to pennies on the dollar or possibly even to forgive the debt but take over the equity wiping out the common shareholders. Companies can file for bankruptcy protection or debt holders can effectively force companies into bankruptcy if they default on their debt payments.
Just understand your downside. Are your shareholders going to bail you out if you have a big customer loss and can’t service the debt or fall off covenant?
What will your lender do? Are they going to throw a lock on the door and sell the chairs? It’s not necessarily the end of the world to default on secured debt. As a founder, you may he just fine after a lender-induces a recap.
But don’t leave that all to chance. Understand the downside risk before you draw down on debt and be comfortable with it.
Debt financing would be wonderful (note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever other completely unrelated thing is making you sanctimoniously kneejerk that "debt is bad". Can we please have an informed discussion of debt as a part of a business capital structure?) for software businesses, which have very predictable capex costs.
The issue was always that bankers don't want to lend for, basically, cultural reasons. When it actually starts becoming possible and there start being standard diligence scripts, etc., it will be much more favorable than equity financing for basically anyone who can get it.
How does debt help deal with "very predictable capex costs"? You would need very predictable revenue to make it work, otherwise equity financing seems like it might be preferable.
Debt financing generally makes more sense for capex, not opex. Servicing the debt becomes an opex, basically, so it would be weird to finance opex out of it.
I don't think it's only cultural, software businesses also have very few assets that could be liquidated. Volkswagen might finance 2/3 of everything it does with debt, but if it just stopped tomorrow and sold all production facilities then lenders would get more than half their money back. If a typical software startup stops operating and sells off all its assets it gets a bit of spare change and the lenders leave with close to nothing.
I'm really not sure if that's the case. With some stuff (eg: car fleets) which are pretty liquid they may get a return. But on some super specialised machinery for VW which only makes VW specific parts they are going to really struggle to get any money for it.
Industrial machinery is usually more fungible/configurable than that. No one (except the secondary parts makers) has much use for the dies to stamp out Tiguan fenders, but lots of sheet metal fabs (inc other auto makers) can use the stamping presses. It might be 30¢ on the dollar, but that’s likely better than the office chair and laptop that a software startup will leave behind.
The claim was different : that maybe 2/3 of their business activity was financed, and if it was liquidated tomorrow the lender would be able to get “more than half” of that back.
The users paying each month are the assets in this article’s thesis. As long as when a company shuts down, they transition their users to a new entity (since they are valuable reoccurring revenue), the lenders will get paid.
Are you imagining a successful company with a large book of users generating a healthy ARR? If that’s the situation, the lenders will get paid, because the business will keep running.
The more likely risk to a bond holder is that the company fails to generate a healthy business, pays most of the loan out in salary while trying, and now the lenders own the company which is a couple of two year old laptops and a few thousand per year in ARR that cannot be profitably served.
The essay is explicitly talking about the former. Rather than sell a bunch of dilutive equity at Series B, a company with decent recurring revenue could collateralize that revenue stream and sell it.
In what situation would you opt for a dilutive series B where you had enough revenue that a bank would collaterize it for you?
If you are profitable, then it’s probably wiser to not take the dilution round. If you aren’t, your revenue is likely worthless as I can’t imagine a bank would have the risk appetite to turn a money losing venture into a profitable one by taking it over
Right, but if you were profitable and, I’m assuming the reason you needed the money was sound; you’d have to be incredibly unlucky if the only outside capital you could raise was a down round.
You usually only hear downrounds from companies that are struggling to keep the lights on
If I were lending, there is no way I would consider recurring revenue to be a reasonable asset. Depending on the business it could go away in a heartbeat at the mention of the company going into administration/receivership. If the software is at all important to the users and it has alternatives, they will jump ship as fast as possible.
My experience in software companies is that there are often a few key developers with full platform and domain knowledge, and they are your bottleneck for onboarding and they are the columns that keep your platform going. Should they leave when the business goes into receivership, and why shouldn't they, there is little guarantee the software will keep running long enough to keep users happy enough, to continue to service that debt.
Not to mention a software business that runs on recurring revenue from users is likely failing because the recurring revenue isn't enough to cover costs, keep the business running and it just makes more debt. I just wouldn't consider it a reasonable assumption that recurring revenue will continue to recur. It's not even a good assumption for a well running business.
How do you assure that users will transition to something that will pay the lenders? If a SaaS startup goes down tomorrow and the VC backers or lenders don't own the direct competition, then when users jump ship the VC backers or lenders have nothing. The SaaS startup's cloud space can't be sold at auction, they probably rented any office space, and the employees will take their CV elsewhere. The IP might be salvageable if patented or otherwise unique but that's still a long shot given any direct competition.
No where in there is a method to retain users or shift them to benefit the VC backers or lenders and recover debt. Maybe via user data that can be sold or pitched as useful to a competitor? Maybe by standing up a competitor and advocating users shift there an can migrate their accounts?
Usually you do a voluntary reorganization between the creditors and the business in the event of default, and a business with steady revenue is often an asset worth owning.
"note to non-business-savvy readers: this is not even remotely the same kind of thing as personal credit card debt or whatever other completely unrelated thing is making you sanctimoniously kneejerk that "debt is bad". Can we please have an informed discussion of debt as a part of a business capital structure?"
I understand your frustration and, largely, agree with it. You are correct that these are two different things and shouldn't be conflated.
Until they should be.
The two "types" of debt you are drawing a distinction between (or the familiar discussion of national debts vs. household debts, usually in the context of federal spending vs. austerity, etc.) do indeed behave differently under normal circumstances.
In extreme cases, however, these heuristics that you find so primitive and annoying are relevant and actionable. Ignore them at your peril.
Debt and VC are just sides of the same (multi-sided) coin. The money has to come from somewhere - domestic savings, commercial profit or sovereign wealth.
The unicorn phenomenon is easier to explain this way - if you are already a company that can consume huge amounts of debt (you have a business model, product and route to market and just need to replicate) then you used to have one choice - take on debt. Now, where the returns on money as debt is so low, the money may choose to be VC just to gets return.
As such the only likely way "debt is coming" is if interest rates climb, giving money an alternative to VC.
However what drives global interest rates as very little to do with tech sector (I think).
So - yes huge tech plays are going to become more and more common because software is eating the world and we are basically going to replace all our business has governmental processes with new software ones.
Those will need huge investment - but whether that is debt or VCor something inbetween (looking at you government bonds) - is more likely to be a function of interest rates than anything else.
My prediction - the next YCombinator will take VC sized money and deploy it at bank level scale - small and medium sized companies at non-unicorn stages, because with good software and models it will be feasible to deploy at smaller levels.
> As such the only likely way "debt is coming" is if interest rates climb, giving money an alternative to VC.
Surely that's backwards: a lot of money really wants to be invested in debt, and is only doing VC because the returns to debt investing are so bad. Offer those investors a better alternative - comparable returns to a second-tier VC fund (which is not actually that hard), with something they can pretend is a security backed by something (they want to believe, you don't have to give them much), and they'll beat a path to your door. Much easier to offer market-beating "startup user bonds" while interest rates are low than when (if) some decent bond investing opportunities come back.
I think we are saying the same thing - at the moment money chooses to be VC funds because normal debt has such low interest rates.
Yes I absolutely think there will be shake ups in VC market meaning smaller more frequent and earlier investment (taking the place of what used to be bank business loans). And I think a lot of money will want to do that.
But both of these are not debt - and until savings rates globally change then there will be plenty of supply of money and interest rates will remain low.
Given that savings rates generally correlate to countries growing in wealth then SEAsia and Africa suggest there will be a long while before interest rates tip up structurally
> I think we are saying the same thing - at the moment money chooses to be VC funds because normal debt has such low interest rates.
> Yes I absolutely think there will be shake ups in VC market meaning smaller more frequent and earlier investment (taking the place of what used to be bank business loans). And I think a lot of money will want to do that.
> But both of these are not debt - and until savings rates globally change then there will be plenty of supply of money and interest rates will remain low.
Low interest rates on normal debt are exactly what creates an opportunity for a novel kind of debt, which is what the article is talking about. Right now there's a lot of money in VC equity that would rather be in any kind of decent-yield debt - even novel debt backed by unconventional collateral. As and when interest rates rise, all that money will go back into conventional debt and the opportunity will go away.
I'm not sure entering the bond market is possible. These "startup user bonds" would be unrated, beyond junk, accessible only to accredited investors, etc. The debt would probably take the form of some type of a CLO or ETN wrapper? I'm just speculating here. Anyone with better insight?
Rates are so low on high yield bonds that investors are pouring money into private credit which is invested by alternative asset managers like Blackstone/GSO
not sure of one specific number. Say you have achieved product market fit and the lifetime value of your customers (LTV) is less than three times the cost of acquisition, you probably be better of getting leverage from debt and gain marketshare. Depends on the market you operate though.
debt and intellectual property do not mixup since by definition there is nothing to back up the debt (unlike real estate or any other industry outside of software).
The author suggests to backup of the debt with a revenue stream, but those :
1) depend on the churn rate.
2) Are stable only for mature companies. Post product-market fit.
If you open graphs over inflation and interest rate since 1971 you will understand why debt is not coming again in nominal terms until the dollar goes away; that is in real value compared to something that you cannot borrow to buy:
Great read, but I had a sneaky suspicion the entire time he was going to just say 'securitise revenue streams', which he finally did.
I just don't think for the most part this will happen in any meaningful way, because high growth companies that need the money just don't have the track record to really underpin the value of said revenue streams.
As for more established tech companies ... surely they must have been doing or at least trying to do this already?
I'm really not sure what's the point of the article. The idea that there is no debt yet in "tech" isn't even true. Uber, WeWork, and especially Tesla have been raising capital via debt. Not to mention Brex which covers the tail end of the startup market with "debt backed by revenue". I'm putting it in quotes because it's a ridiculous idea.
As far as I can tell Brex literally just “lends” money to people that already have money. They lend based on cash in the bank and have the right to debit cash straight from the bank account. It hasn’t been clear to me that they’re even involved in any kind of actual issuance of debt in a meaningful sense at all.
Once a company has substantial money (runway) they’d just move to a better banking provider. Brex seems geared toward start-ups not companies that make money. Weird business model.
> As far as I can tell Brex literally just “lends” money to people that already have money. It hasn’t been clear to me that they’re even involved in any kind of actual issuance of debt in a meaningful sense at all.
It's exactly the same as Chase lending an individual Google engineer $5k for free for the month on his Visa card despite the engineer having $50k in his savings account already.
Debt is a liability to be served, having returns and margins winning over growth, adding a not-so-silent participant to the mission. Welcome to the real world.
> Furthermore, in the Bay Area Founder-VC scene, FK/PK tension simply isn’t perceived as a problem. Founders increasingly think of themselves as capital allocators who think in bets, and the angel investing scene has brought founders and VCs together as social peers. There’s no FK/PK tension between investors and founders. They all want the same thing, and they all hang out at the same parties. The tension has simply been redistributed, largely onto employees. The greatest trick VCs ever pulled was convincing founders, “you’re just like us.”
Recommend reading the whole article if you're curious about the nuance in this. It flies above the current milieu.
I agree completely, but it's worth pointing out that a big reason for this is that Cambridge and Boston have vastly fewer and worse connected VCs than the bay area. I did try to pursue VC funding for a hard-tech startup (thin film deposition for making solar panel conductive pastes), but there was really only one VC group that was relevant so there wasn't exactly a surplus of opportunity money-wise just waiting for a good use.
Personally I think bootstrapping is way better for startups that intend to be acquired or don't mind growing slowly (or don't mind never really growing much at all). Nothing wrong with "lifestyle businesses".
After a few tries, now I have a consulting company that helps people develop their weird scientific equipment and commercial prototypes. I don't really care about funding with that model, and my salary went up 3-fold in one year versus a job at a startup in Oakland.
I'll probably create a product soon, I have a prototype about done and I'll definitely try to make a business out of it -- but because most of my income is consulting I can also afford to move slower, do it right, and not have to hire anyone to help with it unless I actually find traction and need help with manufacturing them.
Short plug: I'm making color changing strobe light art pieces that use the ganzfeld effect to cause vivid geometric illusions -- not novel in the concept, but the implementation is really good after a decade of casually improving it over time. If this sounds awesome to you do feel free to send a note so that I can let you know when they're ready =)
http://neltnerlabs.com is the website, I haven't mentioned the art piece on it yet since it's not done but here's a youtube video of the basic hardware before being put into a frame.
>don't mind growing slowly (or don't mind never really growing much at all). Nothing wrong with "lifestyle businesses".
Are we ever gonna stop saying "lifestyle businesses" for business that don't want to grow 10% per month, and finally call them "businesses" like they are? If you want to make a difference, call them "non-startup".
Most businesses don't grow 10% per month, and they're still full fledge "businesses" with people working seriously on them, full time, not leisurely on the beach in Thailand.
Yeah... once you are no longer a small business interest as defined by the government, you are at least at the tail end of the period you should be able to call yourself a startup.
It's just a buzzword if the company is more mature than that. Maybe it helps them get job applicants or something to market that way. Or get a bigger multiplier on their valuation relative to actual profits.
Yeah, that's why I put it in quotes ;-) I also dislike it, by that definition the people running the corner market are running a "lifestyle business". I run a business. I am not trying to get a $10M exit. Maybe that disqualifies me from being called a "startup", but indeed I am still... starting it up...
So in the context of the hackernews crowd at least, it's useful to make a distinction between business with a goal of growing rapidly, or providing a service as an independent entrepreneur that may grow in a natural way but which is not really desirable to force things with.
Personally I just think of myself as running a consulting business.
Edit: On contemplation, I think really the issue is that "lifestyle business" is treated as a derogatory. I've gotten over that, I'd happily agree that I'm running a lifestyle business. It's a business designed to be a good fit for my lifestyle, to let me make money doing what I love to do. Like an independent plumber or something. That's also a lifestyle business in very reasonable interpretation. She sets her own hours, finds her own clients, does the work herself, for a living. Lifestyle.
So maybe the issue you're picking up on is that "lifestyle" is being used as a derogatory, whereas I (and my current mentors) think it's just a decision for how you want to live. I want a business that lets me do what I want to do with my life, I am not ashamed of wanting a lifestyle business. I can also see why you'd want to avoid it... at least in the bay area. Because of ancillary impacts on people's perceptions.
If I get so much work that I can't handle it, I'll encourage someone I think is really great to be an independent businesses by guaranteeing their first non-exclusive contract so that they can get a running start. Sure, it's a "gig economy", but very limited in scope and at least they're truly independent and able to use that baseline income as a springboard to do their own great thing.
Thanks! It is way trippier in person. But yes, I put up so many strobe warnings that I think it'll be alright ;-) Hope so anyway! I actually enclose the whole thing in a pop up tent so it's impossible to see without reading the signs first, seems to be a good way to show the piece.
A lot of that is sour grapes. The majority of people who loudly explain that they wouldn't want a large VC round are people who aren't in a position to raise a large VC round.
Eh taking a lot of VC money opens up some options (hiring up fast, pouring money into marketing) and closes down others (being acquired for a modest amount and actually making anything as a common stock holder). It’s not right for every business.
I had thought of that but the people I'm talking about are people who had raised VC and later realized that if they want a sustainable business instead of a unicorn they may have missed the boat by working with VCs.
I think like everything VC money has it's place but I think you need to be really sure about what potential end states you are happy with for your company before taking a VC investment.
> The greatest trick VCs ever pulled was convincing founders, “you’re just like us.”
I don't follow how that's a trick VC's played. Founders really are investing in companies. In one of the most extreme cases, see Adam Neumann going around talking crazy for years making all kinds of big bets that all blew up spectacularly, and after this all erupted as a scandal that tanked the company he was given a cool 1.7 billion dollars to walk away.
If there's any trick being pulled, it's that each founder gets several times more equity than the size of the entire option pool (i.e. than all the employees they will ever hire put together), and are able to do things like take millions of dollars in cash off the table when they raise new rounds of funding.
In successful companies the founders really are much more on the financial than production side.
When a founder becomes a VC, his interests in the company he invests in are different than the founders interests. That difference in interest should be obvious but since they portray themselves as founders first, which they were before, instead as VC, which they are now, it confuses that distinction. Agree that it was written a bit too strongly as an attack since I don’t think VCs are malicious when they do that (most at least).
If you don’t believe that, then see other comments that describe how founders in almost all other places other than Bay Area (Boston, NYC) prefer bootstrapping you VC.
Though one way I’m not convinced by the article, in my view what keeps the tension low and manageable in the Bay Area is the amount of money and small number of major firms, which makes treating founders well a key long term strategy, otherwise they’d get less deals (supply vs demand) rather than the power law distributions of this “phase” of tech firms. This long term strategy hasn’t evolved in Boston, NYC, Atlanta, etc, so VCs don’t play up their former founder roles, and the tension between VC and startup is easier to see.
Anyway, it’s not a bad thing, I would question the deal making abilities of founders who don’t see it, and just recognizing these tensions and finding win-win ways to resolve them is a woefully unrecognized part of growing a business.
"Any one customer may be unknowable, but cohorts of customers can be modelled and understood decently well."
Just substitute "mortgage" in this sentence, think back on events of the last decade, and you can see what is horribly wrong with this article.
Lots of debt, all given to tech startups, which will almost all go bust with the first recession. Let's see, what does that remind me of?
Of course, if you believe that the government would step in to take the downside, then you could just get the upside in the time between now and when the downturn comes.
Yeah but unlike a mortgage (secured against one static asset i.e. a house), the article assumes most of this debt will be issued against the strength and quality of a company's various recurring revenue streams (even speculating that different components of this could be financed separately to try and account for the varied risk).
Just need to make sure you don't end up with financers/banks/rating agencies colluding to bundle multiple companies together and sell tranches of the debt (all with a phony A+ rating) to investors/funds...
The question I have is how you know the customers won't cancel their subscriptions when the recession hits, or because a competitor provides the same service for less, or has better service?
you can use CDS to insure performance of your high quality A+ "recurring revenue" bonds. It is pretty cheap for high quality A+ bonds.
>>Just need to make sure you don't end up with financers/banks/rating agencies colluding to bundle multiple companies together and sell tranches of the debt (all with a phony A+ rating) to investors/funds...
but that is exactly the point of the securitization and high skill in doing it which would allow to bring all those sweet pension fund money into play. "financers/banks/rating agencies colluding " - it like saying violin and piano players colluding in Metropolitan Opera performance.
To push that point further, we had it easy in 2008 because governments used QE to push more money into the economy and prop up banks, but what if they can't grab that free lunch next time?
The article seems to advocate for exactly what you’re warning about:
Why not go straight to securitizing senior tranches of your recurring revenue, and moving it off your balance sheet?
... (one paragraph later) ...
On the other side, imagine how much investor interest you could get in a diverse basket of recurring revenue from, say, 10 different startups that’ve all raised from Tier 1 VCs. People talk about how great it would be to invest in a unicorn basket; this would probably be even better.
Except for the part about everyone colluding to get good risk ratings. If that collusion did happen, then yes, these would be the equivalent to MBS'. That can happen regardless of what is being securitized.
It still wouldn't get to the level of the housing crisis until those securities were packaged into much larger CDOs and refinanced based on the fraudulent risk ratings.
> Just need to make sure you don't end up with financers/banks/rating agencies colluding to bundle multiple companies together and sell tranches of the debt (all with a phony A+ rating) to investors/funds...
I imagine that's sarcastic, because that looks a lot like the description of a VC...
The largest difference should be that VCs are transparent about their risks. I don't think any investor expects not to lose nearly all their investment in the case of a bubble popping, what is different from people buying home loans.
The 2008 financial crisis was largely created by the perception that the government would take any downside. As long as we don’t have multiple generations of politicians campaigning on a platform of “every family deserves their own SaaS business” and buying up the debt, we’ll be fine.
You don't need that many participants in a bubble for it to have systematic impact. You just need enough participants inconveniently placed throughout the economy who stop paying their bills to various people.
> The 2008 financial crisis was largely created by the perception that the government would take any downside.
The government didn’t take the downside for each home loan borrower, but when it came to asset prices, they sure as hell stepped in to save all the equity owners. It just depends how much political power the bailout needers have. Just a few months ago, coal miners in West Virginia got a bailout of their pensions when others have been told to pound sand.
> Lots of debt, all given to tech startups, which will almost all go bust with the first recession. Let's see, what does that remind me of?
So will all of the equity. I'm against debt in general as a means of funding and financing because it dissasociates the interest of the debtor with the creditor. But having debt as an option functions as a great competitor to equity based funding, which means that it gives founders more leverage to get better deals in either system.
Note that people out there are parking money in negative interest rate bonds today: wouldn't that money be better served in low yield-AAA debt on tech companies that have the business model to back it?
The difference here is that most investors in these kinds of "securities" being issued by tech companies would demand more data than the investors in securitized mortgage assets did. In lieu of performance data, investors in MBS relied on ratings from ratings agencies that were dependent on the business of the banks that issued the securities. The failure of ratings agencies to accurately assess the risk in the securities is the reason the MBS vehicles grew in popularity (they all looked AAA!) and also why they exploded.
Well mortgages actually can be modeled well if people are willing to look at the actual risk. MBS markets are still existent today and work just fine now that banks got bitten and are still paying attention.
Can't find it now but I remember reading about a recently launched Seedcamp or Point Nine portfolio company that is doing this for B2C SaaS companies I think. You let them plug into your stripe metrics etc. and they then give you debt based financing (using AI/algos to determine amount and rate based on your numbers: churn, growth, recurring revenue etc.)
Sort of thought the whole point of SaaS businesses with lots of employee frills and perks was to eventually attract the activist investors, leveraged buyouts, asset strippers, and other private equity managed debt, as a way to deploy institutional and pension money. Maybe it was cynical, but the point is to generate a long term trickle of ARR that is greater than the interest payments on a debt financing of control of the company, which at a product level is why you need sticky APIs that get baked into institutional customer infrastructure that will yield 10-15 years of locked-in revenue.
One of said vultures above raises debt from group of funds, buys a SaaS company, installs managers who understand cost optimization with no concept of growth, and hollow it out.
Their nut is paying the interest back to their pension fund creditors, and their yield (after fees, naturally) is the delta between what they can squeeze out of cost reductions and making that nut.
I won't name the companies I think will be those targets, but speculating about privately held security companies as an example, it sounds like there is a clear exit sized at 10-15x revenues for anyone with traction, an API, and an office that has free snacks and a climbing wall.
I think this article is trying to make something out to be more than it actually is. Debt financing is a specific vehicle that can be used tactically for a relatively mature business (Series A area +) with predictable revenue for specific growth I do not see it as this magical solution to the current issues of VC capital because alignment is often really out of wack in the early-stages before established product-market fit with high dilution and higher investor leverage.
In a mature business investors and founders are likely to be more aligned anyway because the founder's model has been working and has some length of history and predictability with regards to forecasting further growth and outcomes.
To put it plainly while you can get screwed in the later stages you're much more likely to get screwed in the early stages of running a company.
With that in mind, one of the main benefits, as stated in the article that the debt investment is not dilutive, is still nice at the later stages but I wouldn't say people should exclusively decide to go with debt based on that reason alone because the largest dilution (and by consequence chance to be screwed) typically happens in the earlier rounds (unless you're getting bailed out) anyway.
At the moment, way more VC money is going into later stage deals as companies stay private longer... that is the chunk that if securitisation becomes mainstream , where VCs will have competition. The impact of this could be really fascinating - VCs would be forced to go even broader in their earlier stage investments, or VC’s own funding will start to reduce as it won’t be possible to deploy the capital at the same return. Maybe it’ll turn out that funding more pre seed companies will be successful - why stop at YC’s 200 every six months. The switchover period would be an entertaining time to be a founder, that’s for sure!
Interesting article. The reality is places like Silicon Valley bank do provide debt financing. If your SAAS cash flows look like fixed income, that’s a better way to finance them. There is downside to this too.
The irony is many traditional businesses that use debt (retail?) really should be equity financed.
Less any bright eyed startup founder take this post too seriously, I’ll spell it out: venture debt is bad.
Debt issued to established companies is an essential mechanism to bridge working capital needs - like GM procuring millions of pounds of sheet metal before selling thousands of cars. This is not controversial.
Venture debt issued to startups by bankers, especially by the kind of bank who fancy themselves as a Bank for Silicon Valley, and the types of bankers who, after a few too many cocktail parties with VCs, fancy themselves venture capitalists. It’s just these pseudo-venture capitalists have the risk tolerance of...bankers.
If you pioneer a new space, particularly in consumer electronics with high working capital needs and you are initially successful you will be offered venture debt. If you take it, you will be more successful and you will have copy cats. Some of those copy cats will be FAANG companies.
When this happens the bankers will freak out and pull your working capital. Or exercise a clause that forces a premature sale. Or...or..or.
Woe to you if you were banking on that to make this years Black Friday/Christmas demand.
Alex’s post highlights a need in the space. Don’t confuse it with the services currently offered.
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[ 3.0 ms ] story [ 186 ms ] threadYour overall point appears to be that a repeat of 2008 is immanent and this point can be better made without the "Debt is dumb" first sentence.
This attitude is dumb.
I say this as someone who had enough saved to buy a car in cash: Buying it via a loan was the right choice. It boosted my credit rating and more importantly when emergencies came up I had that cash on hand.
Either rich enough where it doesnt matter, or poor enough where it doesn't matter.
In my case, my first job (at 14) required getting a ride to from a coworker with a car. Getting to university for my job working in the computer lab + my courses required either a car ride from a neighbor or 3 hours on the bus. After I moved away for my first salaried job, I needed a loan (thankfully a personal one and not from a bank - both of which are things many people don't have access to!) to cover my first month of expenses so I could move and actually start getting paid and building measurable savings, since the move already exhausted the savings I had left over after uni.
Money doesn't come out of thin air. Not everyone starts their working life with access to enough money to just buy a car (even used!) and rent an apartment.
You answered your question with the second paragraph...?
>In my case, my first job (at 14) required getting a ride to from a coworker with a car...
You chose to go to university in lieu of financial stability. That is how savings is not acquired. Save the money, then go to school. Buy things you can afford, including school.
>Money doesn't come out of thin air. Not everyone starts their working life with access to enough money to just buy a car (even used!) and rent an apartment.
Babies are born without jobs or means to clothe and shelter themselves, but we have what are called families, communities, and society. Each melds together to form a fabric of civilization that provides in one way or another the necessities of life. Start working as young as possible, save up, spend thrift.
I have no idea why people __LOVE__ making these statements. 2008 was something that affected mostly the US and while it affected the rest of the world to a certain degree, overall very little changed.
Before jumping on my throat, hear me out: There have been several significant financial events since then: the European debt crisis, then Portugal(which is relatively small on a global scale), same with Ukraine and Venezuela, Russia(still going 5 years later), Brazil and those are just off the top of my head. What I'm trying to say is that financial crisis occur almost every year. Keeping your finances tidy is a good life advise but prophecies shouldn't be the motivation for it.
US is back on top. How's Italy, Greece, Spain etc doing?
Spain's growth rate has been what, 0%? Greece is totally screwed, and there's a strong set of evidence to say Brexit was a direct result of the 2008 crisis (because they pushed back so hard on austerity.)
Nah. The only selling point on the referendum was immigration. The only one people really cared about anyway.
Italy and Spain are recovering - new businesses are emerging, unemployment in Spain is down by 12% from 26%, Italy is at ~9.5% unemployment.
Comparing several small countries to the US is completely pointless given the difference in population, area, industry , resources and so on...
Regardless, nobody can tell the future - there are simply too many unknowns to consider. We will certainly have more good times and bad times. As to when they come, predict all you want, but historically analyst predictions have an awful track record (historically, expert predictions are wrong most of the time https://www.cxoadvisory.com/gurus/ ). The occasional person who guessed right previously (there will always be some) are then raised up as oracles.
There will be a downturn, sooner or later. Predict it every year and eventually you go down as the person who predicted the downturn.
That’s the story; hard to say how well it describes reality but there’s surely a modicum of truth in there at least.
So, unless you believe you can time the market, it doesn't appear like there is much to do except to make sure you have a rainy day fund.
All my other money goes into the system.
This only makes sense if you are making a sharp distinction between the 2008 US crisis and the European debt crisis, which is probably not what the parent meant. That's why people would strongly disagree with you.
Eventually, so much debt will be accumulated that companies will not be able to pay off the interest and the bubble pops. If everyone is always in debt, there will always be a periodic crash.
You may want to see the following illustration by Ray Dalio about how debt complements the economy:
https://www.youtube.com/watch?v=PHe0bXAIuk0
They are barely related to the point they should probably even be called different things.
Business debt is to buy equipment to make stuff to sell at a profit.
Personal debt to buy a nice boat.
"Here is a widely believed cause-and-effect relationship I bet you’ve never thought to invert before: because most startups fail, therefore equity is the best way to finance them. Have you ever considered: because equity is how we finance startups, therefore most startups fail?"
At the very least, this lines up perfectly with my startup experiences and many other case studies I've seen - investors simply are not willing to accept reasonable growth or reasonable returns, they want massive scaling and massive growth. Sometimes that approach works out but very often you get expensive bets that never deliver on the level they need to and the startup flames out or ends up stuck constantly trying to clean up the mess left by the last big bet while trying to execute on a new one. A revolving door of new executives and new business strategies.
The venture debt industry depends on tight relationships with VCs to ensure reasonable repayment rates. In some cases they reduce risk by reselling part of the debt. In all cases, they're themselves leveraged, lending money from limited partners and not just themselves.
Yay Hacker News!
It is also like medicine in that it has a tendency of ending up being worse than the condition it was meant to cure when taken irresponsibly or in too large a dose.
There's another way in which debt resembles medicine: those who sell it are wont to sell it as widely and at as high a price as possible, no matter whether it is the right medicine for the condition at hand.
When used responsibly debt can be a net positive. When allowed to run amok it is a burden upon society. Maybe debt, like medicine, should only be allowed to be taken with a prescription?
The CEO/CFO should have the freedom to self-prescribe, IMO. In that regard, debt might be more like food. Some businesses have a chronic need for debt and can live quite fine with a lifetime of healthy debt usage.
Isn't it though, really?
The bankers determine your "need" and price it according to the risk of you defaulting -- which would seem to put a kink in TFA's argument since most startups fail, the interest rate would be astronomical if true risks were priced in.
Moreover, it often makes sense to not pay down debt even if you can afford it. Like if I can get a fixed 30yr 3.5% mortgage, why would I even want to pay it off? I can do a ton of different things to make more than a 3.5% return per year. Of course, I’ll have exposure to some risk, but that’s not necessarily a bad thing.
Looking at places like Japan who eschew debt as much as possible, the affects are not positive. Businesses are moribound and hampered by their irrational aversion to debt.
Mathematically, debt scales future expected return and risk by the same amount. Without debt, investors wouldn’t be able to implement their risk preferences, which surely would make the economy worse for everyone, especially those with little capital.
- someone said this to me early in my career and it has stuck with me.
When did the discussion about “financing structure” become a discussion on ethics? Or are you already taking the “bullshit business hockeystick promises” as a “given in the industry”?
Why are fraudulent business practices the first thing that come to your mind?
If you told me about WACC and how equity is like actually really expensive way of financing: ok, I get it, some cool discussion on a provocative questionmark.
Kind a telling on the industry in a sense :-D
Use it or lose it as they say.
Equity is the most expensive financing - especially for startups.
The opportunity costs for funding a “high risk of failure startup” that even just has your money sitting on a bank account is fairly high. When S&P500 markets return 20% p.a. - I’d wanna see 100+% return p.a. on my risky startup (it is of course less of a normal distribution kind of thing, more a “lose many and maybe win one”).
So actually due to inflation and the opportunity costs associated with the risks you have - stuff may or may not depreciate unknowingly.
Watches are only gonna be worth what a seller gives you when the need of selling it arises. Correlation breakdown between asset classes etc etc has made many people not so happy about the decisions they made with more exotic investments and the believe that “not everything depreciates”.
A more fundamental and underlying problem may be: we print too much money and inflation is probably hitting insane levels but “hidden well beneath the improvements in society’s productivity”.
In a Knightean’s risk sense, we may actually be constantly facing “uncertainty” but believe we are dealing with a more predictable concept of “risk” in our lives. Taleb has written a few good books on it.
I’ll take your equity any time. Your debt not so much.
Burning through other people’s cash on false promises IS NOT the same as having a more equity heavy financing. Either you fund your companies operations through equity or you fund it through debt. So how on earth are you going to fund a company if you don’t want to do equity or debt?
I’m an equity guy. Funded all my shit with my own money and enjoyed the upside. So you’ll get an exclamation mark you can downvote in addition in this post:
!
I would think the debt holders would rather cut a deal than let the company go belly up. $.50 on the dollar is better than zero cents on the dollar.
It just seems to me that if a company is doing something profitably, that would be the company I would want to lend money to.
When getting a mortgage, one of the things the companies will look at is your income to debt ratio. For a company it's no different. Yes, there have been companies that have gone under for too much debt. There have also been plenty of companies that have done well even with debt.
When you hear people say "OPM", aka "Other People's Money", what they typically mean is taking on debt and paying it down over time.
And for the poster who stated you don't have to service equity... that's completely bullcrap. We've all heard stories of VC's shuttering a profitable company because they weren't profitable ENOUGH. There's a cost to everything, that equity isn't free.
[1] https://media.gm.com/media/us/en/gm/news.detail.html/content...
As you can see, 15% interest rates will do that. But this is one of those weird PE setups where the left hand is lending to the right hand.
What will your lender do? Are they going to throw a lock on the door and sell the chairs? It’s not necessarily the end of the world to default on secured debt. As a founder, you may he just fine after a lender-induces a recap.
But don’t leave that all to chance. Understand the downside risk before you draw down on debt and be comfortable with it.
The issue was always that bankers don't want to lend for, basically, cultural reasons. When it actually starts becoming possible and there start being standard diligence scripts, etc., it will be much more favorable than equity financing for basically anyone who can get it.
The more likely risk to a bond holder is that the company fails to generate a healthy business, pays most of the loan out in salary while trying, and now the lenders own the company which is a couple of two year old laptops and a few thousand per year in ARR that cannot be profitably served.
If you are profitable, then it’s probably wiser to not take the dilution round. If you aren’t, your revenue is likely worthless as I can’t imagine a bank would have the risk appetite to turn a money losing venture into a profitable one by taking it over
You usually only hear downrounds from companies that are struggling to keep the lights on
With debt, you promise a fixed rate of return instead, so the benefits are capped for the purchaser.
My experience in software companies is that there are often a few key developers with full platform and domain knowledge, and they are your bottleneck for onboarding and they are the columns that keep your platform going. Should they leave when the business goes into receivership, and why shouldn't they, there is little guarantee the software will keep running long enough to keep users happy enough, to continue to service that debt.
Not to mention a software business that runs on recurring revenue from users is likely failing because the recurring revenue isn't enough to cover costs, keep the business running and it just makes more debt. I just wouldn't consider it a reasonable assumption that recurring revenue will continue to recur. It's not even a good assumption for a well running business.
No where in there is a method to retain users or shift them to benefit the VC backers or lenders and recover debt. Maybe via user data that can be sold or pitched as useful to a competitor? Maybe by standing up a competitor and advocating users shift there an can migrate their accounts?
I understand your frustration and, largely, agree with it. You are correct that these are two different things and shouldn't be conflated.
Until they should be.
The two "types" of debt you are drawing a distinction between (or the familiar discussion of national debts vs. household debts, usually in the context of federal spending vs. austerity, etc.) do indeed behave differently under normal circumstances.
In extreme cases, however, these heuristics that you find so primitive and annoying are relevant and actionable. Ignore them at your peril.
VCs don't want to lend to startups because you can't make 100x return on debt.
The unicorn phenomenon is easier to explain this way - if you are already a company that can consume huge amounts of debt (you have a business model, product and route to market and just need to replicate) then you used to have one choice - take on debt. Now, where the returns on money as debt is so low, the money may choose to be VC just to gets return.
As such the only likely way "debt is coming" is if interest rates climb, giving money an alternative to VC.
However what drives global interest rates as very little to do with tech sector (I think).
So - yes huge tech plays are going to become more and more common because software is eating the world and we are basically going to replace all our business has governmental processes with new software ones.
Those will need huge investment - but whether that is debt or VCor something inbetween (looking at you government bonds) - is more likely to be a function of interest rates than anything else.
My prediction - the next YCombinator will take VC sized money and deploy it at bank level scale - small and medium sized companies at non-unicorn stages, because with good software and models it will be feasible to deploy at smaller levels.
Debt may not be coming so soon
Surely that's backwards: a lot of money really wants to be invested in debt, and is only doing VC because the returns to debt investing are so bad. Offer those investors a better alternative - comparable returns to a second-tier VC fund (which is not actually that hard), with something they can pretend is a security backed by something (they want to believe, you don't have to give them much), and they'll beat a path to your door. Much easier to offer market-beating "startup user bonds" while interest rates are low than when (if) some decent bond investing opportunities come back.
Yes I absolutely think there will be shake ups in VC market meaning smaller more frequent and earlier investment (taking the place of what used to be bank business loans). And I think a lot of money will want to do that.
But both of these are not debt - and until savings rates globally change then there will be plenty of supply of money and interest rates will remain low.
Given that savings rates generally correlate to countries growing in wealth then SEAsia and Africa suggest there will be a long while before interest rates tip up structurally
> Yes I absolutely think there will be shake ups in VC market meaning smaller more frequent and earlier investment (taking the place of what used to be bank business loans). And I think a lot of money will want to do that.
> But both of these are not debt - and until savings rates globally change then there will be plenty of supply of money and interest rates will remain low.
Low interest rates on normal debt are exactly what creates an opportunity for a novel kind of debt, which is what the article is talking about. Right now there's a lot of money in VC equity that would rather be in any kind of decent-yield debt - even novel debt backed by unconventional collateral. As and when interest rates rise, all that money will go back into conventional debt and the opportunity will go away.
https://news.ycombinator.com/item?id=20942950
The author suggests to backup of the debt with a revenue stream, but those :
1) depend on the churn rate. 2) Are stable only for mature companies. Post product-market fit.
https://www.whythings.net/Images/Inflation_chart.jpg
https://beta.theglobeandmail.com/legacy/static/folio/mortgag...
Technology; like money, can't change physics. Just like when you hit a ball; what goes up must come down.
While looking at the graphs, consider that the personal computer and the internet were invented in the 70s. We went to the moon then too.
Virtually nothing in technology has changed since the 80s.
I just don't think for the most part this will happen in any meaningful way, because high growth companies that need the money just don't have the track record to really underpin the value of said revenue streams.
As for more established tech companies ... surely they must have been doing or at least trying to do this already?
It's exactly the same as Chase lending an individual Google engineer $5k for free for the month on his Visa card despite the engineer having $50k in his savings account already.
They make money on the interchange.
Recommend reading the whole article if you're curious about the nuance in this. It flies above the current milieu.
Personally I think bootstrapping is way better for startups that intend to be acquired or don't mind growing slowly (or don't mind never really growing much at all). Nothing wrong with "lifestyle businesses".
After a few tries, now I have a consulting company that helps people develop their weird scientific equipment and commercial prototypes. I don't really care about funding with that model, and my salary went up 3-fold in one year versus a job at a startup in Oakland.
I'll probably create a product soon, I have a prototype about done and I'll definitely try to make a business out of it -- but because most of my income is consulting I can also afford to move slower, do it right, and not have to hire anyone to help with it unless I actually find traction and need help with manufacturing them.
Short plug: I'm making color changing strobe light art pieces that use the ganzfeld effect to cause vivid geometric illusions -- not novel in the concept, but the implementation is really good after a decade of casually improving it over time. If this sounds awesome to you do feel free to send a note so that I can let you know when they're ready =)
http://neltnerlabs.com is the website, I haven't mentioned the art piece on it yet since it's not done but here's a youtube video of the basic hardware before being put into a frame.
https://www.youtube.com/watch?v=eFte1ggIVjM
Are we ever gonna stop saying "lifestyle businesses" for business that don't want to grow 10% per month, and finally call them "businesses" like they are? If you want to make a difference, call them "non-startup".
Most businesses don't grow 10% per month, and they're still full fledge "businesses" with people working seriously on them, full time, not leisurely on the beach in Thailand.
It's just a buzzword if the company is more mature than that. Maybe it helps them get job applicants or something to market that way. Or get a bigger multiplier on their valuation relative to actual profits.
So in the context of the hackernews crowd at least, it's useful to make a distinction between business with a goal of growing rapidly, or providing a service as an independent entrepreneur that may grow in a natural way but which is not really desirable to force things with.
Personally I just think of myself as running a consulting business.
Edit: On contemplation, I think really the issue is that "lifestyle business" is treated as a derogatory. I've gotten over that, I'd happily agree that I'm running a lifestyle business. It's a business designed to be a good fit for my lifestyle, to let me make money doing what I love to do. Like an independent plumber or something. That's also a lifestyle business in very reasonable interpretation. She sets her own hours, finds her own clients, does the work herself, for a living. Lifestyle.
So maybe the issue you're picking up on is that "lifestyle" is being used as a derogatory, whereas I (and my current mentors) think it's just a decision for how you want to live. I want a business that lets me do what I want to do with my life, I am not ashamed of wanting a lifestyle business. I can also see why you'd want to avoid it... at least in the bay area. Because of ancillary impacts on people's perceptions.
If I get so much work that I can't handle it, I'll encourage someone I think is really great to be an independent businesses by guaranteeing their first non-exclusive contract so that they can get a running start. Sure, it's a "gig economy", but very limited in scope and at least they're truly independent and able to use that baseline income as a springboard to do their own great thing.
I've raised large rounds in the past, both corporate and VC, and I've learned to be wary about misaligned incentives.
Now - I don't go around saying: "Don't raise VC ever!", but I'm a little more attuned to the trade-offs than I used to be.
I think like everything VC money has it's place but I think you need to be really sure about what potential end states you are happy with for your company before taking a VC investment.
Making massive win/lose bets only makes sense if you’re diversifying across a portfolio.
I don't follow how that's a trick VC's played. Founders really are investing in companies. In one of the most extreme cases, see Adam Neumann going around talking crazy for years making all kinds of big bets that all blew up spectacularly, and after this all erupted as a scandal that tanked the company he was given a cool 1.7 billion dollars to walk away.
If there's any trick being pulled, it's that each founder gets several times more equity than the size of the entire option pool (i.e. than all the employees they will ever hire put together), and are able to do things like take millions of dollars in cash off the table when they raise new rounds of funding.
In successful companies the founders really are much more on the financial than production side.
If you don’t believe that, then see other comments that describe how founders in almost all other places other than Bay Area (Boston, NYC) prefer bootstrapping you VC.
Though one way I’m not convinced by the article, in my view what keeps the tension low and manageable in the Bay Area is the amount of money and small number of major firms, which makes treating founders well a key long term strategy, otherwise they’d get less deals (supply vs demand) rather than the power law distributions of this “phase” of tech firms. This long term strategy hasn’t evolved in Boston, NYC, Atlanta, etc, so VCs don’t play up their former founder roles, and the tension between VC and startup is easier to see.
Anyway, it’s not a bad thing, I would question the deal making abilities of founders who don’t see it, and just recognizing these tensions and finding win-win ways to resolve them is a woefully unrecognized part of growing a business.
Just substitute "mortgage" in this sentence, think back on events of the last decade, and you can see what is horribly wrong with this article.
Lots of debt, all given to tech startups, which will almost all go bust with the first recession. Let's see, what does that remind me of?
Of course, if you believe that the government would step in to take the downside, then you could just get the upside in the time between now and when the downturn comes.
Just need to make sure you don't end up with financers/banks/rating agencies colluding to bundle multiple companies together and sell tranches of the debt (all with a phony A+ rating) to investors/funds...
>>Just need to make sure you don't end up with financers/banks/rating agencies colluding to bundle multiple companies together and sell tranches of the debt (all with a phony A+ rating) to investors/funds...
but that is exactly the point of the securitization and high skill in doing it which would allow to bring all those sweet pension fund money into play. "financers/banks/rating agencies colluding " - it like saying violin and piano players colluding in Metropolitan Opera performance.
Why not go straight to securitizing senior tranches of your recurring revenue, and moving it off your balance sheet?
... (one paragraph later) ...
On the other side, imagine how much investor interest you could get in a diverse basket of recurring revenue from, say, 10 different startups that’ve all raised from Tier 1 VCs. People talk about how great it would be to invest in a unicorn basket; this would probably be even better.
It still wouldn't get to the level of the housing crisis until those securities were packaged into much larger CDOs and refinanced based on the fraudulent risk ratings.
I imagine that's sarcastic, because that looks a lot like the description of a VC...
But it was a description of VCs.
Massive boring banks won’t get swept up like they did with MBS products otherwise.
The government didn’t take the downside for each home loan borrower, but when it came to asset prices, they sure as hell stepped in to save all the equity owners. It just depends how much political power the bailout needers have. Just a few months ago, coal miners in West Virginia got a bailout of their pensions when others have been told to pound sand.
So will all of the equity. I'm against debt in general as a means of funding and financing because it dissasociates the interest of the debtor with the creditor. But having debt as an option functions as a great competitor to equity based funding, which means that it gives founders more leverage to get better deals in either system.
Note that people out there are parking money in negative interest rate bonds today: wouldn't that money be better served in low yield-AAA debt on tech companies that have the business model to back it?
Plenty of people properly modelled sub-prime mortgages, and made bets accordingly. Corporations are pretty good at modelling cash-flow, too.
I think you're conflating "an inability to do so" with "caring about the results".
They can model individual risk pretty well I imagine. But can they model systemic risk?
The sums are pretty small right now, but the basic model is there.
One of said vultures above raises debt from group of funds, buys a SaaS company, installs managers who understand cost optimization with no concept of growth, and hollow it out. Their nut is paying the interest back to their pension fund creditors, and their yield (after fees, naturally) is the delta between what they can squeeze out of cost reductions and making that nut.
I won't name the companies I think will be those targets, but speculating about privately held security companies as an example, it sounds like there is a clear exit sized at 10-15x revenues for anyone with traction, an API, and an office that has free snacks and a climbing wall.
In a mature business investors and founders are likely to be more aligned anyway because the founder's model has been working and has some length of history and predictability with regards to forecasting further growth and outcomes. To put it plainly while you can get screwed in the later stages you're much more likely to get screwed in the early stages of running a company.
With that in mind, one of the main benefits, as stated in the article that the debt investment is not dilutive, is still nice at the later stages but I wouldn't say people should exclusively decide to go with debt based on that reason alone because the largest dilution (and by consequence chance to be screwed) typically happens in the earlier rounds (unless you're getting bailed out) anyway.
https://www.fca.org.uk/consumers/mini-bonds
These havent been getting good press recently due to a number of failures.
The irony is many traditional businesses that use debt (retail?) really should be equity financed.
Debt issued to established companies is an essential mechanism to bridge working capital needs - like GM procuring millions of pounds of sheet metal before selling thousands of cars. This is not controversial.
Venture debt issued to startups by bankers, especially by the kind of bank who fancy themselves as a Bank for Silicon Valley, and the types of bankers who, after a few too many cocktail parties with VCs, fancy themselves venture capitalists. It’s just these pseudo-venture capitalists have the risk tolerance of...bankers.
If you pioneer a new space, particularly in consumer electronics with high working capital needs and you are initially successful you will be offered venture debt. If you take it, you will be more successful and you will have copy cats. Some of those copy cats will be FAANG companies.
When this happens the bankers will freak out and pull your working capital. Or exercise a clause that forces a premature sale. Or...or..or.
Woe to you if you were banking on that to make this years Black Friday/Christmas demand.
Alex’s post highlights a need in the space. Don’t confuse it with the services currently offered.
How is this different than the "next round" of a venture raise vaporizing and being left with no money?
https://earnestcapital.com/