Why your VC doesn't like Debt by Jason Garcia

TL;DR - VC’s want equity, not debt. This is due to debt being paid back before equity.

Helpfulness - 4

Topic Tags - Venture Debt, VC incentives, Debt service, capital stack, leveraging

Questions answered:

  • Why do VC’s not like debt (as an asset)?
  • What is the capital stack?
  • How should founders leverage?

Summary:

  • Debt puts a cap on the amount of money a VC can make of an investment. Also, debt is cheaper than equity, which basically means debt creating interactions are more worth it for the founder and not as much for the VC.
  • Debt service means paying back debt with interest, which can be worrisome depending on the start-up’s cash flow.
  • Start-ups who have to pay back debt burn through the money VC gives them at a faster rate and also creates a “robbing Peter to pay Paul scenario,” which VC’s are not found about.
  • For founders, “it’s important to keep debt service to less than ⅓ of total burn”
  • The capital stack states mean employees and taxes are paid first, then debt, then preferred stock, then common stock. Anything paid before the preferred stock is bad for VC’s when a start-up goes bankrupt or even successfully exits.

Follow-up Links:

Venture Debt