Opinion: Going for debt vs venture capital, risk vs returns

Photo credit: retrorocket / 123RF Stock Photo.

Recently, there were two big stories from the venture world of the West. The first one was Walmart’s acquisition of ModCloth, a retailer of women’s clothes.

Debt, as most of you would know, sits on top of equity. ModCloth was facing trouble raising their next equity round after having raised a US$20 million debt round. In the end, Walmart pounced and acquired the company for a great price (roughly US$70 million) right when the debt was due.

Then, six days later, this came out: Struggling Music Service SoundCloud Raises $70 Million in Debt.

SoundCloud had been trying unsuccessfully to raise an equity round for some time. However, it did not find a suitor and ended up raising debt to survive.

So what do the two have in common? You guessed it: venture debt.

I decided to write about venture debt for early-stage companies (read before reaching good unit economics). At GREE, we have done only one deal—as far as I can remember—where venture debt was used as an instrument to complement the equity round. This was very recent, so the story has yet to unfold on that one. But overall, the company’s contribution margins seem good enough to support the debt.

Due to my limited experience in this space, I decided to start with some thoughts from industry leaders on this subject.

Fred Wilson

“I’m not a fan of venture debt for early-stage companies. If the startup is getting the money because of the credit worthiness of my firm and the other firms in the deal, then I’d rather be putting more equity in instead and getting paid for my capital at risk. I’ve told this to every venture debt lender who has come to see me, so it’s not a secret how I feel about this kind of funding.”

Dan Primack

“Debt is not inherently troublesome for startups, particularly if it’s supplementing equity as opposed to substituting for equity. But startups must recognize that not all cash is created equal.”

Erin Griffith

“The best time for startups to raise debt are: (1) when the company is growing, but not fast enough to get a bunch of new equity investors interested, (2) when unit economics actually work but there is a valuation gap or management does not want to be diluted further, (3) when the company is close to profitable and equity is too expensive or will take too long to raise, (4) the company is more than ten years old and equity investors are tapped out in their older funds.”