Today’s startup scene is all about raising VC money — as much as possible, as fast as possible. The market celebrates VC fundraising, cheers unicorns and makes it seem like VC-backed startups are the holy grail of innovation. And so my fellow entrepreneurs were somewhat surprised to learn that when my VC-backed startup needed another cash injection, I resorted to the oldest trick in the book — I went to the bank.
All Investment Dollars Are Not Created Equal
I started an e-commerce company as a broke college student, my first investors being my Harvard Business School professors. Since then, I’ve raised a total of $11.5 million in investor and VC financing from the likes of Upfront Ventures, Mousse Partners and angel investors.
Four years into the business, we were tripling our multi-million-dollar revenues each year, and the prospect of growing our sales nine-fold was imminent. While we could easily reach this target fueled solely by customer-generated revenues, I wanted to reach this goal sooner rather than later, and identified that a $4 million cash injection — a relatively small amount compared to our current revenues and past financing — would allow us to reach this target by end of 2016.
While the natural route for many would have been to pick up the phone and call their VCs, I wasn’t rushing to hop on that call. Our valuation was strong, but as a $100 million revenue company it would be that much stronger. Raising VC money at that point in time would have been like giving them a gift — I would inevitably be diluted by 15-30 percent, in return for a bigger amount of money than what I needed to triple growth over this year and next.
Startup founders are not exactly every banker’s wet dream.
Besides, the value I could afford to look for in this new round of money was substantially different than my early fundraising days four years ago. Indeed, in the early day of starting a business, money is never a generic — I wanted advice. I was on the lookout for specific VCs or angels with a targeted set of skills, expertise and network they could tap into in order to grow the business.
But as the business grew, money became more generic: I already had the guidance I needed from my experienced investors, and even if smart advice and a strong network are great, I could make a dramatic impact simply by getting the pure dollar value, no strings attached.
This is when the notion of a bank loan first came to mind, which, in the Silicon Alley startup scene, can be somewhat of an incongruity — a bank loan is everything but startup-trendy.
First of all, startup founders are not exactly every banker’s wet dream. Entrepreneurs are used to pitching a vision and selling you on the future. Banks, on the other hand, are not that interested in your elevator pitch. They want to know where you are now, not where you’ll be four years from now — they are on the prowl for hard-fact figures, down-to-earth financials and robust guarantees. Not exactly a match made in heaven.
Secondly, low-risk investments are music to traditional bankers’ ears; as a result, they favor assets to use as collateral — many startups won’t have any tangible assets for many years to come. As an e-commerce business that designs its own merchandise, we had inventory making us solid candidates from the outset.
The preconception that bank loans are ill-suited for startups is not completely unfounded.
But still, this doesn’t apply to many incredibly successful startups. Airbnb’s Brian Chesky recently shared his rejection emails from VCs — you can only imagine the response he would have gotten from a traditional bank.
Thirdly, and most painful, bankers often look for positive cash flows, which many startups cannot provide. A viable solution for negative cash flow startups who look for alternative financing is venture debt, but that comes at the price of loan shark-worthy 12 percent interest rates and overwhelming covenants.
And so, the preconception that bank loans are ill-suited for startups is not completely unfounded. Yes, bankers look for the business of today and not of tomorrow, gravitate toward low-risk investments and strongly favor positive cash flows. But the real problem is not that bank loans are ill-suited for startups. The real problem is that a far-too-large number of startups are irresponsibly managed, making it impossible for themselves to get a bank loan even if they wanted to.
The Recklessness Of Over-Inflated, Over-Hyped, VC-Backed Startups
VC-backed startups are getting an increasingly bad reputation for being financially irresponsible. Stories such as Zirtual, which grew to 400 employees in one year without its founder and CEO knowing its burn rate, and Fab, which burned through $200 million in two years without ever proving their business model, are getting more common.
Startups that, with the first sight of VC money, balloon into over-inflated teams, unsustainable business model and artificial, VC-money-fueled growth, are not doing the rest of us VC-backed startups — who managed to stay lean and efficient with a team of 70 employees servicing more than 4 million customers — any favors.
But the startups are not the only ones to blame — some VCs are part of the problem. Not holding over-eager, over-zealous and careless entrepreneurs accountable and continuing to throw money at them, certain VCs are sustaining unprofessional behavior, high burn rates and irresponsible management practices. Indeed, many early stage startups and entrepreneurs are looking to VCs for guidance; unfortunately, many VCs are not your ideal responsible adult.
We avoided the high-cash burn-rate syndromes and uncontrolled hiring sprees, we had a strong financial matrix and assets. This meant that despite being a startup, we were not that risky a bet. And so, we made our way to the good old bank.
Believe It Or Not, Courting Banks And VCs Is Surprisingly Similar
To my surprise, the funnel for securing a bank loan was not that different than raising VC money. Back in the days of our first financing round, I contacted 30 VCs; 20 of them agreed to meet with me, and 20 percent of those sent us a term sheet. In comparison, we contacted 12 banks; nine of them agreed to meet, and 40 percent sent us a term sheet. The funnel from reaching out to getting in the door and getting a serious conversation going was surprisingly similar.
The amount of paperwork required by the bank was striking.
The due diligence process with the bank, however, was far more cumbersome. We underwent a full-fledged financial audit. It was long, thorough and demanding — especially recalling that for our VC funding, which was three times as large, I only provided market studies, a business model, a budget and projection for our use of funds.
The debt-raising process ended up taking nine months from the first application to the actual loan signing, with seven months of negotiation on the term sheet. This was not that far off from the time tables of a significant financing round, though, granted, the debt size of $4 million would not be considered a significant round.
The Underlying Pros And Cons Of Bank Loans
So my company got its $4 million bank loan, with no dilution and no additional business perspective to take into account. But still, it was in no way with no strings attached — the depth of covenants and amount of paperwork required by the bank was striking. For example, we now need to report our full financial results every month, including listing all our partners, suppliers and stock levels. In comparison, VCs require a board update only on a quarterly basis.
More cumbersome than VC scrutiny, the bank covenants raised our finance team’s workload by approximately 10 percent. We were already disciplined, and had the infrastructure in place to meet the bank’s intrusive requirements — but any startup that is not already disciplined would have been completely overwhelmed.
If there is anything I learned from my experience, it is that bank loans can be a surprising fit for a certain kind of startups, and that they encourage discipline and restraint — values still too rare on the startup scene. If I could give advice to startups struggling to monitor their cash flows, it would be to get a bank loan to make sure that they finally have a responsible adult present.