New VC Strategies: Venture debt or angel money?

venture_capital.jpgAlex wants to grow up and be a VC.

(Possiblly so he can afford to hire personal protection and prevent further beat-downs.)

 Here's Alex's idea for funding startups:

"If I like the entrepreneur and the company or idea, I will fund it, up to a certain amount, using the following simple formula (sample dollar amounts only, actual invested dollars will of course vary):


Amount Invested = $250,000

I own 75% for my cash investment, entrepreneur owns 25%.

The moment I receive my $250,000 back with a 20% increase (for a total of $300,000), the equity flip-flops. I own 25%, the entrepreneur owns 75%.

This simple method allows for a few things to happen. First and foremost the entrepreneur is highly motivated to get my initial investment plus interest back to me as fast as they possibly can. I don’t care how they do it. Bank loan, profits, home equity line, friends and family, outside investor - it doesn’t matter. Once they pay it back, they own their company again, until then, I own it. I don’t want to run it or mettle in their business. In fact, I won’t do that. But the fact that I own 75% will motivate any entrepreneur worth their salt to hurry up and change that around.

When they pay me back, I will still get to participate in their company as a shareholder, and hopefully I can add value as a 25% owner. They will be in control though and I will be along for the ride.

Why is a 25% equity stake in your company too much to ask for funding the entire business with no personal risk on your end? All i make is a 20% return..."

Ok Alex, you asked for it.
Let's take a look at a situation like this from the entrepreneurs perspective. 

What you're offering is venture debt with a few unusual caveats.

  • You'll lend money without a personal guarantee on flat rate terms of 20% for which you take 75% of the equity.
  • You'll take a 20% return.
  • You'll keep 25% of the company.

So here come the problems: 

  • Why would I take on venture debt for a 25% stake (if everything works perfectly) when an angel will take the same equity postion up front  (typically 20-30%) without ever taking control of the company.
  • When does the 20% have to be repaid?
  • Say the company is growing fast. You own 75%. What would prevent you from wresting control of the company from the entrepreneure minority shareholder?

You're right that banks don't fund startups without personal guarantees. (Been there. Done that.) But the capital markets are highly efficient and there's a reason that they're structured a certain way. (Please believe that I'm not arguing that there aren't better ways.) You might be able to give money to a company, but only a very deperate one. Any startup that can attract an angel round can do so without giving up control of the company at all.

Charles River has their new CRV QuickStart Seed Funding Program. You'll notice some fundimental differences in how the transaction takes place. Charles makes their terms very attractive, but of course they're looking to stay on for future rounds.