Let’s mug a startup founder
thinkvitamin.com
thinkvitamin.com
First of all the loan we are talking about is a ‘soft’ loan to the businesses taking part – with no personal guarantees and will be interest free.
As part of the application process we’ll sit down with each team to understand their funding needs and will only ask for the loan to be repaid once / if this level of funding or more has been achieved, or they reach a level of profitability to support loan repayments, again we will agree this in advance but the key point here is that we will build in an agreed level of headroom with the founders.
This will not be a complicated loan agreement, we only want to have the money back to reinvest in the next round of entrepreneurs when its right for the business, i.e., there wont be any clever call options. Teams will be given full sight of this and we will encourage them to get advice before they sign up to anything.
To promote it as "Breathing life into tech startups" is irresponsible.
Well, that is a preferred equity instrument, eg, "This bit gets paid before the common equity gets a dividend or distribution."
Preferreds generally have a stated "interest" rate, but payments are at management discretion (accruing to principal when not made) but there is no reason that can't be zero. They can also have maturity dates for repayment. Yes, it looks a lot like a loan, and that's sort of typical for this "junior to all other obligations / senior to other equity" layer of the capital structure. (And note that there could well be legal and tax differences between preferred and debt. I don't know how it complicates the documentation you're already doing with the loan and equity pieces. IANAL.)
The important difference for you is jargon. "Preferred equity" doesn't carry a suggestion of personal liability, it's equity with a return clearly tied to the venture's success, but ahead of the common. Your founders won't know the term, but any advisor they speak with should.
Described thus, I still don't know if I like your proposition, or what others should think of it, but I'm closer to understanding just what that proposition is.
They're only looking to be paid back if you reach profitability.
6% equity to get a $33k loan and some sort of training/advising for 13 weeks at their facility, and office space afterwards? Could be a good deal, especially if you have a new business that requires medium amounts of capital costs to get started. If you're getting something manufactured and your first run/prototyping/etc is going to run you $15k, it might be good to do that on their dime. If it works out and you get profitable, you pay them back and they've got their equity. If it fails, they're out the money.
Could be good, depending on your circumstance and the specific terms on it. I could see lots of cases where that'd add far more than 6% chance of success and value to the business.
Edit: Gosh, a lot of reply comments. To clarify:
-You should always, always read the terms carefully in any important contract you're going to sign, and strongly consider hiring a lawyer to give it a once-over.
-In this particular deal, you'd want to make sure the loan isn't personally guaranteed and what the terms of calling it are.
-I could see times where I'd be ecstatic to take this. Lots of brand new companies would have a much higher success chance and EV with 94% equity, $33k cash in the bank, and $33k in debt with flexible repayment terms than 100% equity, $0 cash, and $0 debt.
-Money's worth a lot, and people often underestimate how much it's worth. Especially for an unproven, speculative venture.
-It might or might not be a good deal depending on your specific circumstances, and the exact terms of the loan. Again, read contracts carefully and strongly consider hiring a lawyer to look it over.
-As always, consider not making flippant comments on Hacker News? It's kind of tiresome to get ignorant and flippant replies when you're trying to do a neutral, factual analysis.
> When do I have to pay the pre-seed funding back? Don’t worry, we really don’t want you to hand over the keys to your house or car – this is a soft loan. Our interest is in your success and therefore will only look for the loan to be repaid when it makes sense for your business. This will be done on a case-by-case basis.
It makes it sound like the loan is to the business - with limited liability, you don't have to pay it back if the business fails.
They say they're flexible on being paid back, and do it on a case by case basis. Anyone doing it should read the contract/loan terms very carefully to make sure there's no personal guarantee and what Oxygen's rights to call the loan are. But assuming the contract terms match the general vibe they've got on their site, it could be a good opportunity. Again, depending on the specific terms and circumstances.
And the structure isn't necessary to meet the stated goal of an "evergreen" fund, as equity returns on successful venture should fill that need.
It's an odd structure, at best.
Anyways, yes, you should always read the terms on an important contract very carefully, and here's no different. Probably a bad deal if there's a personal guarantee on the loan.
But assuming the contract is square, I could see circumstances that I'd take this deal in a heartbeat - starting a brand new company with 94% equity, $33k cash in the bank, and a $33k loan with very flexible repayment terms seems like it'd have a much higher chance of success than starting with 100% equity, $0 cash, and $0 debt.
BTW. I don't see what's wrong with a personal guarantee. It's nice that you are willing to risk other peoples money, but I think you should be ready to "make one heap of all your winnings, and risk it on one turn of pitch-and-toss". Then you'll be a man.
Your lender is not risking his house to loan your company money and you shouldn't risk your house either, especially if you have a family. It's not so easy to start over once you get married and have a couple of kids, and it's not worth risking getting thrown out on the street if it means your children are going to be sleeping in the gutter.
On the other hand, this is how most small businesses owners I've met did it. Most of us lack the connections to get people to give us money on "eh, if it doesn't work out, we forget about it." terms.
Hell, try to get any kind of lease as a small company without personally co-signing. "If you don't believe in your company, why should I?" is something that more than one landlord has told me.
So yeah, while you could say it is insane, it's also quite difficult to get a company off the ground without accepting some personal liability on the downside.
The other side of that is when you think about what 'deep in debit' means, you should calibrate that to your own personal earning power. This is easier than it sounds; it's hard to get people to loan you more than you can reasonably pay back. Your creditors fear your bankruptcy more than you do.
From what I've seen, starting a failed business does not decrease your earning power. I know I'm a more valuable employee now; aside from the technical skills I've obtained, I now understand a lot more of what the boss actually wants. (unfortunately, most of that knowledge only applies to small companies. Large corps, it seems, operate under different rules, rules I still do not understand.)
[1] I ended up deciding not to shut down the company, so I continued the arrangement until the company was making enough money to pay me a living wage.
It just means, they rather discuss the terms of loans individually, on case to case basis.
The whole thing smacks of a rich guy who just thinks he can throw around his money, call it an 'accelerator' and take candy from babies.
I'm doubly angry because here in the UK, we're struggling to get support for new startups and entrepreneurs. Shady deals like this only make it harder for people who genuinely want to support startups (like Seedcamp) to gain traction in the mainstream media.
Screenshot: http://i.imgur.com/GCYCG.jpg
My startup applied for YC and (having not made it) will not be pursuing any others. We may apply for YC again, not for the money but the experience and the alumni.
Experience and Alumni.
I probably agree that 6% PLUS a $32k (zero-interest) loan is not a good deal.
But I don't even think 6% for ~$20k is a good deal for funding.
I don't think the comparison you're making here is fair. Calling it a "mugging" is a bit over the top. The people who mug startups are consultants and do-nothing executive hires.
We agree on how valuable $32k of seed money (debt or equity) is worth. To wit: not much.
We agree on how expensive 6% of your company is worth. To wit: a deceptively large amount.
We agree that this seed program is probably not a good deal.
I just think there's a difference between "probably not worth it" and "bad virtually to the point of criminality", which is what the wording you used meant.
But that's a subjective point.
What's not subjective is that an interest-free unsecured loan for $32k USD IS a favor, not a mugging, and while I don't think it's worth 6%, or even 1%, it's not right for me to accuse the offerer of that loan of mendacity.
A question I'd put back to you:
Assume that there is no seed fund or accelerator program you can get to accept you, other than this one. Assume that you need the $32k; stipulate that you cannot, say, bootstrap or consult your way out of the first 6 months living expenses.
Would you advise someone not to start a company instead of accepting this deal?
It's also causing investors to be more aggressive in pushing their money on startups, whether they need it or not. Inexperienced startup founders will mistake their fervor as an indication that they should take the money, instead of an indication that maybe their startup has real potential and they should be slower to give part of it away.
"Would you advise someone not to start a company instead of accepting this deal?"
That's a false dichotomy. There are plenty of companies (ours, 37signals, etc) that started without any funding at all. Then when we decided to raise funding (debt in our case), it was easy to get because we had real revenue and clear growth. It made sense for the bank to loan money to us because it could see we that we were going to pay it back.
Let's all stop spreading this bizarre myth that you have to take part in an accelerator to start a company.
But it's one thing to have it in for all seed funding programs (I'm with you on that!) and another to call one specific one "muggers" because you particularly don't like their terms. At least, not with terms like these.
Finally, just out of curiosity: is your $162k debt financing secured solely with your corporation? You didn't have to provide any collateral, or any personal guarantees? Obviously: I don't think you could pull that off in the US. Unless your revenues are way higher than I assume they are (my current assumption is already pretty high).
When do I have to pay the pre-seed funding back?
Don’t worry, we really don’t want you to hand over the keys to your house or car – this is a soft loan. Our interest is in your success and therefore will only look for the loan to be repaid when it makes sense for your business. This will be done on a case-by-case basis.
Typically, its $10,000 or more in legal help. They dont require you to pay them unless you raise at least $500K in funding -- if you crash and burn before hand and your startup falls apart - they do not ask for any payment.
This happened with me in the past - and I would further recommend their services to anyone.
- It wasn't at all clear from the website that the money would be a loan - I only got confirmation of this after several clicks to get to the FAQ.
- "Case-by-case" basis? Does that mean if they think someone is going to tank they'll ask for their money back? or perhaps they'll want it back before the next cycle?
- As another commenter has said, the phrase "don't worry" from money lenders makes me feel queasy.
I realise the above points are very touchy-feely but compared to what else is out there, I wouldn't be willing to even consider these guys.
How are such loans handled in the UK regarding liability? I mean, if you have a limited company, does one of the founders have to vouch for it with his personal possessions (as it's often handled here in Germany, for obvious reasons)?
Yes, if you're doing good, they won't be hasty in getting the money back, but they just might kick you on your way down, possibly thus ruining your last shot of getting back up again.
Let's say a director of a limited company with a low capital (UK Ltd, German UG etc.) wants to take out a loan on the company. The default risk would be pretty high, and so it's standard practice that the loan contract includes and additional clause that the director is directly liable. Doesn't change the law itself, just an additional contractual obligation.
That's why I'm interested in how the UK banks (and/or this incubator) would treat this. Either they do it the same way, the state takes care of such losses or they're much more eager to accept risks than banks here (which, given recent history, wouldn't surprise me either).
20k GPB for 6% strikes me as rather high, as -- never mind all the aforementioned scrutiny -- getting a loan that high isn't really that much of a deal.
It probably comes down to what can be negotiated and I think it's mostly the same as you describe in Germany: Liability is limited unless you agree that it is not.
As a side note, I've had personal experience of one fund which hoped to get back the money given regardless of success or failure. I declined to get involved with them.
Seriously, though, how difficult is it to get a limited liability going in Germany? Moving there next month.
It cost us 100€ with min of 1€ capital in the Republic + 10€ legal swearing fee. I filled in the form myself.
Anyone who's lost money in their startup investment knows what I'm talking about. ("Oh yeah, I know it's risky, don't worry" ... "Wait, did you try hard enough? What are going to do, jump ship NOW??")
Their idea of an "evergreen" fund is cute, but it's ultimately flawed. Most startups fail.
I suppose it protects them against so-called "lifestyle businesses" that never have a big exit.
(ycombinator can defeat this by continuously manufacturing holy water - just like the old vcs did. the halo effect makes an investment from yc both more valuable and variable than the fixed price on offer)
Note: I don't have the hard data about this, but this seems to be the consensus (although those people never presented their data) and my anecdotal experience. Please, tell me if I'm wrong :)
If things work out, I'll walk away with enough to pay down some of my mortgage, and he'll be set for a life of luxury. But if things don't work out, then I still have a great house, and plenty of savings. He'll have no credit, and no savings.
It seems like a poor use of funding to pay the founder a great salary (i.e. more than key employees) at an early stage startup: before profitability, or even early into profitability.
I am citing from previous experience, when pitching a travel startup to a Natwest 'business' manager his response when I expressed a point about Expedia was.. "who are they?". Enough said.
I just hopped on the web and Googled 'small business loan' and came across Lloyds. I filled out a random contact form and amazingly they got in touch. I had to prepare a traditional biz plan and present it. Because we bootstrapped the startup and revenues showed constant growth, and I was confident in my pitch, they got back to me next day and said they'd do it. Wasn't easy but it worked.
It does irritate me that the UK government bleat on about making business finance readily available then you end up face to face with the likes of Natwest!.
Reading articles about the startup program in Chile and the building of a tech hub in Portugal I do wonder what happened to the innovation in the UK business sector, if the Startup UK website was anything to go by it's gone.
I can't speak for what Oxygen is doing, or whether they're providing these services or not. But many accelerators that aren't called Y Combinator or TechStars are, and though there won't be as many successes to come out of those, there no doubt will be some. There may even be one or two who attend, learn a bit, fail, and then come back to apply at one of the big dogs later down the road.
Q. We could just go get a bank loan and not have to give up any equity?
A. It is true there are alternative sources of funding including bank loans through the government supported Small Firms Loan Guarantee scheme; this loan is only available to companies that can prove the ability to repay it, however these loans charge a facility fee, are interest bearing, have fixed payment terms, and the founders are required to give personal guarantees. The 70% guarantee made to banks by the government only kicks in once the personal guarantees from the founders have been exhausted. Our loan is interest free, has no fixed term, is secured only against the business, does not have any personal guarantees and is only repayable if and when the business can afford it without jeopardy to the business. If the business fails (which inevitably some will) the loan is written off. It is made at a time when in most cases the founders have an idea; they may not have incorporated, may not have a business plan or even a well thought out strategy.
Lots of people have understood what we are offering – here is a comment on HN from ‘lionhearted’ which sums it up well.
“I could see circumstances that I’d take this deal in a heartbeat – starting a brand new company with 94% equity, $33k cash in the bank, and a $33k loan with very flexible repayment terms seems like it’d have a much higher chance of success than starting with 100% equity, $0 cash, and $0 debt.”
Q. Isn’t 6% equity for a 20K loan a ridiculous interest rate?
A. The 6% of equity is not directly related to the £20k. The 6% equity is in return for the full programme, including aftercare. We are enabling companies to reach an entirely new level, through the provision of facilities, mentor guidance, accommodation, investors, an evergreen loan and office space for 6-months – plus we will keep a vested interest, providing an open-door policy to the team in Birmingham. An important point is that it’s a loan of UP to £20k – purely to enable the teams to get onto and through the programme. It is not seen as an investment to last them post-bootcamp, but allows them to reach ‘investor day’. They don’t have to take this loan if they don’t require it.
Q. Why wouldn’t I just bootstrap rather than taking a loan?
A. Bootstrapping is a great way for a startup to get off the ground, but often requires the founders to take on debt via credit cards or loans from friends and family which also have to be paid back. The difference here is we are offering a programme (facilities, mentor guidance, accommodation, investors and office space for 6-months) that includes an interest free loan to your business with no personal guarantees. Here is a HN comment from tptacek
“Loans and lines of credit often don’t require equity. They frequently do require you to put up your house. You cannot pull an interest-free loan, backed only by your corporation, off a tree. It is a real offering. It is not reasonable to call it a “mugging”.”
Q. I’m having a hard time understanding why they want the money back if they’re taking so much equity.
A. Typically it takes 3 years + to get a return on an equity deal so if you are running an accelerator at least once a year you need to be able to fund it for at least 3 years before getting (3 * £200k = £600k + running costs = £1million) any return. By using an evergreen loan model we stand a chance of returning some (not all) money to the programme quicker than 3 years and allowing us to sustain the programme and support more entrepreneurs which has to be a good thing for the entire community.
Q. If we make it big it’ll be 6% of a much larger amount (think $10,000,000+). $600,000 is a little more than the interest you’d pay on a $33,000 loan at 6%?
A. The type of high-growth tech businesses we are looking to support on the programme will need additional rounds of funding and therefore our 6% equity will be significantly diluted. It would be great to think that all businesses will exit for $10million + but the reality is very few will so the return is unlikely to be anything like that.
Q. Not all accelerators are equal
A. I agree and not all startups are equal and what works for one doesn’t always work for another. I don’t seek to compete with Tech Stars, Seedcamp, Y combinator or any other scheme. I applaud their efforts in what they do for aspiring entrepreneurs; any reference I make to them is around the fact that we are offering a 13-week bootcamp that is mentor intensive in order to assist companies in raising their next round of funding.
Q. This is a rip off for startup founders who don’t know any better.
A. I think this does the tech community a dis-service. The vast majority have a very good understanding of these matters and are more than capable of weighing up what is the best programme for their startup. The fact that this is not an identical offering to other accelerators does not make it a rip off, it makes it different.
Q. The loan information is buried in the FAQ’s
A. The FAQ’s are hardly buried they are very clearly displayed on the Accelerator page. All the accelerator sites use the FAQ’s to provide the detail around their programmes. However, to ensure its very clear we have added the words “soft loan” next to the £20k on the home page.
Q Why don’t we just get Angel or VC investment?
A. There are a lucky few startups that turn up and pitch an idea to an Angel or VC and get funding but there are more that are not that lucky and have to actually prove traction, have a credible business plan or be revenue generating. What accelerator programmes like ours do is help your startup get to that stage quickly (13-weeks), which means you are much more likely to then find the investment you need to grow the business to the next stage. Of course this is not the only way to become investment-ready; there are plenty of others and only you can make the best choice for your business.
Q. There are lots of accelerators why do we need one that offers loans
A. My experience is that there aren’t enough accelerators to support startups and many talented individuals with great ideas fail to get the support (financial and non-financial) to get their ideas off the ground. My programme is aimed to support those people that see the value of the programme; if they need neither the money or the support because they have all the skills and connections to go it alone then clearly they wouldn’t benefit from the programme. The fact that hundreds of people applying to Tech stars, Y Combinator and other accelerators aren’t successful suggests there is a need for more support to be provided (YC probably got 1000+ applications and selected 60 teams, so that’s 940 teams who will not receive support this year alone).
The rationale for it being an evergreen loan is so that the ones that do repay the loan, at a time when arguably they no longer need it, is to allow other entrepreneurs the same opportunity for the long term. Other schemes such as Difference Engine were funded by regional grant type funding which, as government cash ran out, were closed and therefore no longer open to budding entrepreneurs, despite the fact that many of the companies that benefited from the programme have gone on to successfully raise further rounds of funding with the assistance of the programme and arguably don’t need the original funding anymore. Our aim is to make the programme sustainable and not at the whim of investor sentiment. The evergreen loan model in theory returns money back to the programme quicker than an equity-only model and hence allows us to support more entrepreneurs.
Mark Hales http://oxygenaccelerator.com/blog/2011/05/oh-no-its-a-loan/
- One acquired - One failed - One currently humming along profitably - One currently growing at an insane pace (thankfully!)