Just read an interesting article from "The Vest Pocket Consultant" discussing fund raising in the current economy, and how we are in a buyer's market, people with money have the negotiating power.
One example in the article is the case of a startup that was offered $2M for 20% of the company, and that went public one year later with a $300M market cap.
While $2M for 20% could look reasonable these days, and even though we are talking about a very specific case, it is interesting to consider the cost of money in this example: the $2M worth of stock were valued at $60M the following year, so this is a 3000% interest rate. And then you realize in retrospect that if you can find $2M at 25% or even 30% interest rate, you are left much richer at the end of the game. AND you do not have to deal with people on your board, a higher cost of transaction (stock deals are more complicated than loans from a legal prospective). Unless you do not mind leaving $57M on the table, this is clearly an option worth looking at.
While this is an extreme example, it is always good to keep this in mind...
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Wednesday, March 11, 2009
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Mark MacLeod 85p · 839 weeks ago
1.) Unprofitable and small companies cannot usually access debt. Certainly not in the same amounts as they can with equity.
2.) Investors get in for one simple reason - to get out at a profit. A company worth $300M is pretty small as the public markets go. I'll bet the existing investors did not get to sell their shares on that offering so their money is still at risk. Low valuations going in compensate for that risk. Given the exit environment these days, it is very uncertain how investors will get their money + a return back.
3.) If you don't repay your debt, in the most extreme circumstance you can lose your whole business. IP is the most important asset a startup has and any smart lender will demand it as security.
Bottom line: VC funding has been and always will be the most expensive form of funding in the market. Still not sure the comparison with debt works as you often cannot choose one over the other.
mdangear 37p · 839 weeks ago
VC money is expensive, and people should be aware of it.
Mark MacLeod 85p · 839 weeks ago
Healy Jones 65p · 839 weeks ago
However, most companies would probably be better off getting a loan than trying to raise venture capital. I don't believe that most businesses are appropriate for venture funding, and advise many of the startups I meet with to not raise $ from venture capitalists.
Wallen's · 839 weeks ago
kulkulkan · 839 weeks ago
mdangear 37p · 839 weeks ago
Which was my point: while VC help in some cases, but it is an expensive option, and you should always remember that there are other options (debt or bootstrapping). I work with a lot of entrepreneurs in Silicon Valley, and many of them have been brainwashed into thinking that the only way to get the business going is to raise VC money, which is not the case.
Guillaume Lebleu · 839 weeks ago
Of course, from a private business standpoint, you should always lower your cost of capital as much as possible and if debt is an option, and our financial capitalistic system favors it, then it should be used, but cautiously, especially with regards to where you are in the business cycle.
I agree with you that bootstrapping is the option to look at first. The cheapest capital is the one you get from saving your profits.