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...
>, 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?
You mean "personally" as in the young company has no material revenue -- and therefore for any "business loan" the founder applies for, the conservative banks will always demand collateral of personal assets including house, car, retirement savings, etc? (The young startup has no business assets such as airplanes, factories, datacenters, etc for the bank to seize in case of non-payment.)
Well then, the "why" should be obvious: VCs can give orders-of-magnitude more money than personally-collateral-backed bank loans can provide. Also, the VCs (the good ones) can dive into their rolodex to help you hire hard-to-find executives. A bank loan officer doesn't have the same motivations.
E.g. In 2005, Mark Zuckerberg got $12.5 million from VC Accel Partners. There is no bank that will give a 20-year-old college dropout with no revenue a $12.5 million loan. Yes, his parents were upper-middle class but I doubt Mark had $12 million in personal assets to secure as collateral for a bank loan.
>, but with the right KPIs it's really not much harder than raising a round.
I think it's very hard to concoct a scenario where a startup founder has virtually equal opportunity to secure $1 million bank loan or $1 million in VC investment -- and the only reason he chose the VC was that the founder didn't have the financial wisdom to choose the debt. I can't think of a case study where that suboptimal decision actually happened.
In other words, the type of business (lifestyle/bootstrap/niche vs mainstream grow exponentially fast) or lifecycle stage (early no revenue vs mature with revenue) already predetermines a path of debt vs VC investment.
Granted, especially for business models with low initial revenue / high lock-in / winner-takes-all properties and for young founders without large assets, you are completely right that there's often a lack of other options.
That being said, other sources of funding than VC (debt, mezzanine capital, government grants, incentivized programs, early temporary monetization options or getting experienced execs as cofounders for real shares (not the usual .5 options)) instead of paying them hard cash with borrowed money later on are often totally overlooked by startups IMHO for their own detriment.
I think you guys are both right. And I'm sure one could construct some sort of venn diagram for startup funding with circles for equity, debt and bootstrapping; where a given startup is a good match for one or more funding choices (based on its biz model, industry, geography, founders, etc..).
(By the way congrats on financing your Series B with revenue, that is awesome!).
Just wanted to add one point in the equity vs debt debate is 'in theory' once a startup gets big enough doing the math on choosing equity or debt is very different. Once a startup is a real company and reasonably calculates how much money it needs and what it expects to earn on that money, an "optimal" capital structure calculation starts to emerge [1] and VCs and banks will compete for your business.
For a healthy, growing startup, if selling a certain % of your equity to a VC looks unattractive compared taking out a bank loan then your equity valuation is being mispriced here. Negotiate it. Conversely if a bank loan looks unattractive compared to VC equity offers (because the bank's convenants are too burdensome and your monthly interest/principal payments pull too much cash away from your growing business then the lender is mispricing your borrower risk). Negotiate it.
To follow on the Facebook example above, I believe they started mixing equity and debt almost immediately as early as 2004 [2]. Their seed investors backed their credit line (WTI invested $25k in equity and provided a $600k credit line). Later, FB took on $100M in debt from TriplePoint about the same take they sold .08% for $120M ($15B post). If you do the math here, then diluting ownership by .08% for $120M that you don't have to pay back vs. writing checks for $150M to pay back a loan over the next few years, the equity starts to look pretty attractive.
Loans can still be a great option - and can offer larger amounts without personal guarantees (e.g.: up to a million with revenue-based financing).
Debt's a great strategy for companies looking to stave off venture capital so that they can improve their metrics in the short run and set themselves up for better term sheets. I know several founders who have saved millions in founder equity as a result of growing with debt financing first.
If you are young and have no assets, you won't get a loan of much value.
If you aren't young and have assets, ones that your family relies on, then you are risking the very foundation of your family--your home, car, savings, etc.
There's a very good reason loans are used more than they are.
Average deal size is $15m which means that the company probably has some mix of equity and debt in their capital structure. Equity can be used to cushion variance in debt servicing payments. Ultimately if you're taking on debt you're expecting that your your ROI is exceeding your debt payment. While some companies may default, an equity position may not have saved them either. Net-net, smart use of debt could generate better returns for VC as an asset class as companies will suffer less dilution and it'll drive stronger selection for companies generating positive cash flows.
I think now is a perfect opportunity for the startup community to work toward changing this. In other words, I think dependence on VCs (or loans in general) for success builds an ecosystem filled with unicorns and everyone else. I think that's incredibly unsustainable and surprised not more people are trying to fix this.
What I think the ecosystem of startups in general (not just tech startups) needs is a continuum where it's more or less obvious how to "plug into" an ecosystem and succeed. And as long as your company is producing a satisfactory product / service (to the customer) you're more than likely going to succeed.
Will this transition happen within our lifetimes? Perhaps not, but I think it's an important thing that needs to be fixed for the future of civilization. Do I even know exactly what this other world will look like? Probably not, but I do believe it assumes there will be far fewer ultra wealthy and ultra poor, and a whole lot of middle class.
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...