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Comment by a13n | Hacker News Reader

> We agree on a Return Cap which is a multiple of the initial investment (typically 3-5x)

Why is this better than just taking out like a 20-30% APR business loan?

Because very few lenders will lend to a business at this stage (relatively little revenue and short operating history), and the few who do will require a personal guarantee and/or personal collateral.

That is, if the business fails, or does okay but doesn't become large enough to service the debt, the founder still needs to pay the loan back. For all intents and purposes, a business loan with a personal guarantee is a personal loan.

That's not true of these terms. If the business fails, the founder doesn't personally need to repay the investment. If the business grows but very slowly, the founder still decides how much to re-invest in the business.

(Also, at the interest rates you mention, such a loan would be no different than taking out $100k in personal credit card debt to fund your business. Yes, someone could do that, but it has some very significant downsides.)

From a quick read of their agreement, it seems like the payments are only made when you are actually making a net profit, whereas a traditional loan would require mandatory payments or interest would accrue.

This seems like a middle-ground that is better suited to starting up companies that most likely won't be unicorns. They only get paid once you get to a "comfortable" spot, financially.

Another consideration may be that in the event of business failure, you'd still owe money on the loan but the Shared Earnings agreement would essentially go away since the business is no longer viable. Not sure about this, but this is what I'd imagine would be the case.

But it seems likely to me that their 'investment decisions' are going to be made based on a run-of-the-mill small business credit model which will be heavily revenue focused.

It's a small business loan with terrible terms.

We're more of a substitute for seed equity. Or at least that's the lens through which we have structured our terms and strategy. Most of the co's we are looking at would not be able to get a small business loan (zero collateral, very limited financial track record by debt standards, etc)

If the loan in to the LLC then the loan would also go away if the company fails. The difference is primarily the deferred payments in case of non-profitability.

Acquiring a commercial loan to your LLC with reasonable rates without a personal guarantee is extremely difficult. In all likelihood, a small business is going to have to make a personal guarantee to borrow money.

The business loan is slowing down your business no matter what.

Earnest only takes their return once you're in the position to pay yourself a salary. If you reinvest everything in the business, they don't get anything.

Yeah, sure. Just seems like paying a bank 20-30% per year is a way better deal than slowly bleeding 200-400% back to Earnest. You're paying WAY more money (read: 10x) for a more flexible payment schedule.

At the stage in which they're investing, a bank loan will generally be secured against your personal assets, whereas the money from Earnest is not. If you raise money from Earnest and your business fails, Earnest loses their investment. If you raise money from a bank and your business fails, you may lose your house or declare bankruptcy.

I don't think you understand how interest rates work.

If you look at the repayment schedule in the model, you'll find that Earnest ends up being CHEAPER than 20-30% without the personal guarantees required by a bank:

https://docs.google.com/spreadsheets/d/1h_L7oa3rbV8P-ZnMM-l1...

A stream of cash flows that goes:

0: -150,000 1: 0 2: 0 3: 1,800 4: 14,400 5: 50,400 6: 97,200 7: 205,200 8: 81,000

The IRR/effective "interest rate" of this stream of cash flows is 18.3% - lower than the 20%-30% you're claiming.

At the risk of not answering the question, I'd say no form of capital is "better" than any other. Capital is a tool and the job of the founder is to find the option (both on payments term and other aspects like mentorship or personal exposure) that best aligns with their goals.

Hey Tyler, thanks for responding.

Sure, I mean different forms of capital are better in different circumstances. So in which circumstances is the form of capital you're offering better than a 20-30% APR business loan?

Asking as a profitable bootstrapped SaaS founder.

Two possible answers

1. When the business is too early stage to get a bank loan

2. When the business is highly risky and the founder doesn’t want the debt burden (not sure if Earnest would fund this either)

We are mainly focused on the early stage when a business loan (ie no personal gaurantee) isn't an option. I went the route you described (racking up $50k credit card debt) to launch my SaaS business and it sucked. That said a business loan could be a great option for more mature businesses with solid cash flow (hopefully at much less than 20-30%!)

The short answer is if your financials are good enough to qualify for a business loan without a personal guarantee, which means you have revenue high enough to service the debt, then that's great.

My guess is that Earnest is investing more money, at a much earlier stage, than when a business loan without a personal guarantee would be available.

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