Is it me, or are we seeing a lot more venture finance deals these days? Web 1.0 holdover Cooking.com is the latest to jump on this bandwagon. It just took out a $7 million loan from ORIX Venture Finance. The ten-year-old dotcom—which is basically a shopping portal for cookware—is one of the early Idealab companies that is still around.
Whenever I see a venture debt deal, I wonder why the company couldn’t get regular venture capital or find another source of funding. Did they get a better deal through the bank loan or could they not find any other takers? With a “startup” this long in the tooth, I suspect it is the latter. I am not familiar with the specifics of this deal, but it is common for venture debt to be structured as a convertible loan, meaning that the lender can convert the loan into stock at some point in the future. [I didn't get this quite right, see update below]. Sometimes these are treated as bridge loans with the hopes that an IPO will make converting the loan worthwhile. If Cooking.com is indeed considering the IPO route (again, pure speculation here), it would be well-advised to radically reinvent itself first. The public markets are not too receptive to Web 1.0 retreads right now (see Classmates.com’s flubbed IPO attempt).
As Allen Stern at CenterNetworks points out, perhaps Cooking.com can use the funds for a much-needed facelift. It could definitely use more content and community features baked right into the main parts of the site, instead of shunting them off to a separate forums tab. When people want to learn about cooking, it looks like content-heavy sites like the Food Network or AllRecipes are more popular destinations:
Update: I’ve been getting comments and e-mails about my characterization of how venture debt works. Apparently, it is not common for venture loans to be convertible to stock, but they often do have extra warrant provisions that allow the lender to invest in future rounds (for equity) alongside other investors. Brightcove CEO Jeremy Allaire clarifies the issue in an e-mail:
Venture Debt is definitely a booming sector right now, much to the chagrin of traditional venture capitalists. Venture Debt offers growth companies the ability to get access to capital without having to give up equity in their companies.
On the other hand, venture debt is essentially a bank loan, with terms that most unprofitable and early stage businesses could never get from traditional banks.
In your post, you suggest that Venture Debt is somehow not as good as venture capital. To the contrary, not only is it potentially better (e.g. you don’t give up ownership and control provisions in your company), it is actually much harder to get than a venture capital investment. Because venture debt is more like a bank loan, venture debt investors are much more scrupulous about who they will provide loans to, and most often are looking for investments in companies who already have a lot of capital/cash and have a very high likelihood to pay that back over 36 months. A startup without any meaningful cash on their balance sheet or growth in revenue would find it extremely difficult to get venture debt.
I stand corrected.
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Even back in 1998 (or whenever), an Amazon-type site focused just on cookware didn’t make much sense to me. How many baking sheets does someone need?
Is “Venture Debt” another name for junk debt?
Plus, the VCs who LEND money instead of getting a share of the businesses they finance must have pretty low expected returns… They not only get a low 15-25% return on the deal (that’s at the high end), but also they get into the risk of having to squeeze the money out of the business if it fails – through lawsuits [not the cheapest way
]
Does a company that lends money deserve to be called a VC company? How about plain old “bank” or “credit union” or a sort of a loan company?
thanks for the link – interesting chart – cooking.com still has 1M a month – not bad! but once again, a Web 1.0 who didn’t want to move forward.
$7 millions for facelift? Well, they could afford plastic surgery for all their employees for that!
“Whenever I see a venture debt deal, I wonder why the company couldn’t get regular venture capital or find another source of funding.”
Huh? In my experience at least, this is backwards. Who wouldn’t take debt over equity? Service is out of free cash flow, rather than your pocket (as a shareholder).
The problem with venture debt is usually you can’t get it when you really need it (running out of cash).
Elementary, my dear Erick. Debt is waaaay cheaper than equity…just ask the $3 Trillion bond market.
As founder of the smaller but profitable BigOven.com, I’m pretty biased, but I definitely feel the opportunity in the food category is much more in the social-network-about-food and productivity aspects of the daily meal preparation grind. We’ve just passed 72,000 registered members and have seen pageviews grow about 400% in 2007. If you can become the place that people check when they are at the grocery store (mobile) or just before they hit the grocery store or online grocery site, it’s a pretty valuable asset, I think. But I agree, it does make one wonder both (a) why they need so much capital to do so, and (b) why debt was the preferred way to go.
Yet another area where you should have asked before posting Erick. Debt is ideally suited to either IP companies (who’ll get bought out for big bucks, but don’t have the track record to get a decent valuation) or companies looking to do accretive acquisitions.
Basically it’s the cheapest form of capital available, cause you get the cash now, typically don’t pay interest while you’re using the capital, and the lender gets warrants (or similar) based on the company’s future valuation (after the acquisitions are complete).
In uber simple terms, if Cooking.com was worth 10M now, and wanted to raise 10M for acquisitions, they’d have to give up their company. OR they could raise 10M for acquisitions based on a post-acquisition value. If the acquisitions add 3M$/year to their bottom line, the company’s value could shoot to 40M, thus only costing 25% (cause there’s no post-money on debt) in equity + about a million in interest / legals over 5 years.
Also, it’s vastly easier to kick out a VC debt funder. Give’em their return and they’re happy.
Ahem “they’d have to give up HALF their company” (10M on 10M is 10M of 20M, so 50%). Stupid blackberry.
Dear Erick,
I am a venture capitalist, in several cases venture debt makes perfectly sense. And for a company, it is more difficult to access to venture debt rather than Equity. In fact it is less expensive than equity. But it is more expensive than Junk Debt. It usually does not work in the way you descriìbe it, nor in the other ways posted so far, I am available for explanations if you need. Also, pay attention, in several cases Venture capital equity has rules that make it very similar to venture debt.
Mauro Pretolani, London
Disregard the case for Cooking.com, wouldn’t debt make sense if you do not want to dilute the number of shares?
They probably used the domain name as collateral!
Looks like it’s still stuck in the 90s
IMHO, seeking VC capital should be a last resort or you have large capital expenses. Why would anyone want a money hungry VC on your back? People make the mistake thinking that VC money is free. Yes VC money reduces your risk, but the agreement/contract you are going to sign is always going to be in the VCs favor. Want to change your business plan or sellout at a low bid, well you will have to get permission from your VC first.
Just my 2 cents, I really do not like TC’s mentality that every website (1.0, 2.0 whatever) needs VC money to be successful. Hey Mike why don’t you highlight self funded startups from time to time (hint hint). Maybe you do, but whenever I visited your site I see the word million or facebook in almost every story.
Here is a video highlighting those who did not seek VC support and look where they are at now.
http://www.myvi....com/video/2629
I guess the question I have is do they make enough in revenue to service the debt of such a sizable loan.?
http://www.whatshottoday.com
They probably need part of that 7 mil to cook them up a new website. Wowza….it looks old school!
yeah still old design – but Im confident they had to atleast show some mock-ups of a new design and a new business plan to get 7mm …
– also Im sure they are pofitable, and debt should mean they can pay it off early before it is converted into – shares of equity.
– its a huge gamble that is betting the company’s status quo vs. todays hot internet market. Its probably a good bet – either way it turns out atleast they tried
They are actually providing the backend for Starbuck’s ecommerce site as well as other major brands…I think this is unaccounted for in the traffic graph you posted. Even though you missed this point, Cooking isn’t a homerun…but you should research beyond Alexa stats
They are just a group of average developers, adding marginal feature enhancements and white labeling their core technology…which they are making work…debt makes perfect sense if you read #9 comment about IP heavy companies
They should roll some of their more active forum participants into column/blog writers. That way they create a bridge between the two content areas without any redesign resentment or user attrition. No need to spend any of that 7mil on a FoodNet star, work with the social you already have!
I don’t know of cooking.com is a good idea or good business and really don’t care. However, I’m glad to see the comments here, because the debt related statements in the article suggest a lack of understanding of venture debt. Several companies I’m involved in (venture partner, board member, Exec Chair, etc) have recently done venture debt deals, (not with banks) and the terms have been very attractive; in fact more attractive than I’ve ever seen before. The statements here that suggest “debt” is somehow inferior to “equity” from a corp/startup finance perspective strike me as uninformed and naive to the level of silly.
In several recent cases, I’ve seen venture debt deals that seem to suggest these institutions are competitively displacing what could have otherwise been venture equity deals. And no, they aren’t bridge or convertible instruments. They aren’t AR factoring, nor asset based. For all practical purposes, they are doing debt deals that serve the purpose that would otherwise have been risk equity, with modest warrant coverage, so limited dilution.
Is this an emerging trend? Is it going to offer a competitive alternative to venture? Seems this would be worthy of a serious editorial piece. BTW, virtually every fast growing company as it matures seeks an optimal balance between debt, equity, and balance sheet assets. It isn’t debt bad, equity good, or venture bad, bootstrap good. But rather, what is the optimal way to resource the establishment and growth of a successful company. Not a simply issue, and I’ve grapple with it as a raw startup, and being CEO of a startup that’s gone public.
Unfortunately, the this piece throws in a drive by shooting of a big and important topic without understanding the domain or current state of the news on financing. So two suggestions. One, consider giving the topic appropriate attention. Two, make sure you know the domain before you go Op Ed.
I know this is coming off as a bit harsh. I do appreciate the “news” here. This one was just an uncommon miss from my perspective.
Debt is cheaper indeed…
It is ok for a startup to borrow – I agree.
The only thing I noticed as weird is “Venture Debt”.
See this: Venture capital is a type of private EQUITY [upper case by MikeT] capital typically provided by professional, institutionally-backed outside investors to new, growth businesses. …
http://en.wikip...Venture_capital
Are we witnessing the birth of a new type of VC business?
A final thought for me here and I’ll stop. Regardless of whether it’s venture debt or venture equity, why do companies think a financing is a newsworthy event? I realize this flies a bit in the face of a lot of what is reported here, but I still don’t get why so many companies make a news event out of a financing? Winning marquis customers… Having key people join the company… Strategic partnerships that drive growth… Merging with another company… Going public… These I get. “Did a debt round”, seems basically analogous to saying we upgraded the TP in the bathrooms at the company. Kind of a financial hygiene factor, but is it really more than that? Clearly, capital in whatever form or source is a needed resource, but it isn’t the value that makes a startup successful. So why all the financing news? I have to admit, talking about startup and operational financing seems like the kind of news you make up when you don’t have anything more important to talk about.
Jesus, it is incredible…
Thanks for the comments on venture debt. I have updated the post. This does seem to be a growing trend, and I will try to learn more.
I agree that whether or not it is better or worse than traditional venture capital depends on the terms of each deal.
Sometimes when a company has had multiple rounds of financing like cooking, a debt/loan placement may be better – for both investors and employees – than recapitalizing the company in another round of financing.
But like others have said, it depends on the uniqueness of each situation. Certainly don’t think its a sign of any emerging trend.
@23: Even if another round of financing is not a big deal to write about, it still helps the ones who are trying to come up with “the next big thing”, “the product that will revolutionize the industry”, etc. to see what’s going on in the market
In more serious terms though, there are no other places to read about it except for blogs like TC and others like it. And since it’s so easy these days to launch a site and so many try to do it, they all form the audience (myself included) hungry for this type of information.
Plus, it helps to guesstimate the valuation of a certain type of business with a certain number of unique monthly visitors. Thus, these articles are welcome.
@MikeT: Private Equity as a capital class is less about cash=equity and more about risk profile.
Venture Debt firms, after all, get “as if converted” equity in the form of warrants (or similar), so they are getting “equity”, they’re just getting it later.
How is venture debt not giving up equity?
Banks don’t give money for free. There is some type of collateral on the line — whether it’s your house or your soul.
No one gives free money friends. No one.
Venture debt isn’t banks. It’s VC firms who do debt-based deals (typically interest + warrants, at least in Canada) instead of cash for equity.
The entire premise of this post is backwards – for the most part debt capital is PREFERABLE to equity capital, and is almost ALWAYS better for shareholders. Any Weighted Average Cost of Capital (WACC) analysis shows this, in part because interest is tax-deductible for all corporations (what matters to shareholders is the after-tax cost of capital), not to mention preservation of equity (equity capital always involves the dilution (AKA “cramming-down”) of current shareholders.
The reason that early-stage companies are forced to raise venture capital is that there’s no way a startup can raise debt capital. Once a company matures, its ability to raise debt rather than having to return to vulture equity may well be a sign of strength, not weakness. (Some VC firms, Sandhill Capital in particular, are increasingly getting into the venture debt business, alongside their traditional venture equity business).
I know nothing about cooking.com, so I have no idea of the details of this particular deal, but any Finance 101 professor can tell you that the premise of this author’s post is backwards.
@ Jeremy Wright: Thanks, Jeremy, but that is already called convertible debt. Interesting how Erick and Co will cover specifically “Venture Debt” in the future.
I think that “Venture Debt” would be the kind of debt that is directed towards startups or businesses in early stages and where the interest rates are higher than junk debt (because the startup business is risky and usually there is not much to secure it with). Well, a company that lends money at around 20% on average and is well diversified will deliver good results compared to the market averages (11%), but this is definitely not the return that VC companies are looking for, hence either the appearance of a new industry, or the change of the term Venture Capital.
As Patrick Bultema mentioned, this is a big topic. So much could be written about it…
PS: Also available for venture debt work, consulting, etc. Would also consider VP level job at ethical firm. There are a lot of sharks out there in this sector, just like VC, I guess. I liked my name to my Linked in profile if anyone cares to learn more. Cheers again, chrisco http://www.venturelender.com
jeremy allaire’s email is correct, sort of, but misleading
venture debt is never — never — available to companies that have not raised lots of venture capital from deep pocketed VCs
a company with cash flows (EBITDA) can get plain old ban k debt, e.g. a revolving line of credit, based on some conservative percentage of receivables. happens every boring day, a killion times over
“venture debt” is for young companies that dont have EBITDA
the lenders are lending entirely based on the confidence of the venture capital investors — as venture debt is senior to equity, VCs have to hand over the company to the venture debt lender if there is a default.
as for the econimics, the premise of venture debt as an asset class (that is, how lenders make money) is
way above market interest rates (today, typically Prime rate plus 5-7%, or 10-12% per annum) plus equity “kicker” in the form of a small warrant (typically a couple percentage points on the amount of the loan, e.g. 3% of the loan is the value of the warrant — if the loan is say $1 million, then warrant is for $30,000 stock, at the last VC price, or lowest price if there is a cram down.)
often a great deal for startups, for sure. but a very very dubious asset class (um, what percentage of venture backed companies fail?) and a sure sign that the bubble is turning into a BUBBLE
This article is further evidence of how uninformed most people are about venture debt. For the author of the article to incorrectly suggest that venture debt is “commonly” structured as a convertible loan exemplifies this notion.
It is not only pragmatic for a later stage company to seek other non-dilutive forms of financing (i.e. venture debt) but it is often in the best interests of management and the shareholders of the company to do so. It certainly DOES NOT portend that the company has no other financing options. In the case of Cooking.com that presumption couldn’t be further from the truth. Furthermore, if the author took the time to understand Cooking’s actual business model instead of writing an article based on pure speculation and lack of knowledge then we wouldn’t even be having this discussion.
Articles such as these do the venture lending community a huge disservice. There is a ton of misinformation out there about venture lending that is being propagated by the uninformed. Testimonials such as Jeremy Allaire’s comments help a great deal in correcting those wrong and oftentimes grossly inaccurate assertions about venture debt.
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