In April we reported that San Francisco based mobile startup Kadoink was heading towards the deadpool. Not because they ran out of money, but because Hercules Technology Growth Capital, one of their backers, had seized the company and was shutting it down.
CEO Scott Cahill confirmed the shutdown yesterday in an email to investors, saying that Hercules had “foreclosed on its collateral and has sold the company’s intellectual property to a third party”:
From: “Cahill, Scott”
Date: Wed, 3 Jun 2009 16:42:29 -0400
To:
Subject: Final Kadoink Update
Dear Angel Investor:This is the final update on Kadoink. On Friday, May 30th, Kadoink completed the sale of its assets. As the attached letter indicates, the company contacted over 600 parties to determine interest in an acquisition of the company’s assets. Of those, 22 expressed interest. Following a due diligence period, the Company received 6 bids for the acquisition of the Company’s intellectual property. Unfortunately, the highest offer was insufficient to pay the company’s secured lender in full. The company’s secured lender, Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc. has foreclosed on its collateral and has sold the company’s intellectual property to a third party. While the details of the transaction between Hercules and the buyer are subject to a confidentiality provision, the company can assure investors that the purchaser is not an insider and the transaction was arms-length.
The Company’s inability to pay its secured creditor in full means that that the Company, with certainty, is unable to make any payments on the general unsecured claims against it. Additionally, investors will receive no return on their investment. The company will be dissolved under state law. Please consult with your tax advisor regarding how you, or your organization, should handle losses arising from the closure of the company.
On a final note, I regret that we were unable to return at least some portion of your investment to you. While we were optimistic at the start of the process that this might be achievable and we were ultimately satisfied with the size of the top bidders given what we learned over time regarding sales such as ours, it is disappointing nonetheless.
I wish you all the best in your future endeavors and investments.
Best Regards,
Scott
Venture debt looks extremely attractive when things are going well for a startup. The dilution to shareholders is minimal, usually just some warrants attached to the debt. It can make a lot of sense to raise debt when building out infrastructure, particularly since the debt can be secured against hardware being purchased.
But the terms of the debt are key, particularly under what circumstances the creditor can come in and shut down the company. Many creditors look for triggers in the financial statements that give them the right to seize assets. That’s likely what happened with Kadoink, and it’s a sad way to end a company that may still have a shot at doing something interesting. Smart entrepreneurs only accept debt agreements that require nothing but payments to be made on time. As long as those payments come in, the creditor has to stay away. Terms are usually less attractive, but in the end it may save you from the deadpool.
Poor founders , but then they raised a hell ofalot of money.
liberta-togo.com
The founders walked off with $4.5 million cash when they left the company/got fired.
Hercules should have to disclose terms of sale to angel investors.
Reason #5489 to avoid VCs at all costs.
did Scott, the CEO who wrote the letter, get a piece of the $4.5M?
Yep you have to wonder how often this happens.
One of the issues I have with taking a convertible note is the ‘ticking clock’ for us to raise the Series A round of funding.
There has to be a value tied to building http://www.Live...hatConcepts.com organically that i’m sure is outweighed by the convertible note terms I’ve seen.
Does anyone have any stats or content around founders who go to the wall unwillingly? or better still those that pull it out fo the bag and raise money to purchase discounted assets
This is the gamble you take with venture debt. It can be used offensively to accelerate growth or defensively to keep the lights on. It has a place, but you sign over ALL assets as collateral.
For anyone interested, I wrote a primer on venture debt here: http://startupc...ebt-primer.html
Dear Kadoink,
On behalf of the angels, thank you so much for your efforts. I can’t wait to read your final email below telling us how you undid the unfortunate position Kadoink has been put in. In your previous email you have shared some truly impressive accomplishments that, I am sure, will not go unrewarded.
I would like to be the first to congratulate you on signing so many deals, building the product and assembling a first rate team! I can’t imagine the list of disappointed job applicants who got a “no” from your talent search! I heard that Condi Rice, Sting, Jim Cramer, Amerigo Vespucci and Yosemite Sam were all disappointed applicants to the team. A high bar indeed!
The list of business partners in the pipeline was quite impressive. How Kadoink did this surely boggles the imagination. So much progress, yet hopes dashed in the final minutes. How could that have happened? Cascades of waterfalls poured from the accounting department detailing every penny spent and the bushels of money that was about to dumptruck right into the open half of the concert hall converted into office that you called “home.” A true visionary. People laughed when the company rented so much office space – it was for quick and efficient dump truck access so they could drop their loads of cash and get out in under 2 minutes. I must admit, I never saw the genius in that one until it was too late.
I know why it all happened the way it did, and I feel bad. Pure ugly unkind fate. Fate doesn’t care who it eats up. The best of us get trampled, right in the middle of a gold medal race. Champions, loaded with spreadsheets and 80 pages of monthly board presentation slides – struck down mid-stride. Not fair! In those slides were hours, days and weeks of careful planning. They themselves could be a new product! You guys were minting new businesses within a new business!
As I begin reading your recent note, I can’t contain my excitement It really sounds like when asset liquidation time comes, you will have tons to sell. The investors can sit back and wait for the booty to roll in. There’s so much that’s been done combined with a pile of cash fuel, you probably turned this puppy into a river of gold. I heard investors got their hopes up when they read what you have accomplished in so short a time on such a minimal budget in the first email. I am sure that a 3x return on capital sounds right. The team, product, prospects. It all pencils.
Wait, I just read the full and final update. Ok, you had 56,401 flyers posted, got fistfuls of interested returns and skillfully turned that into six hungry and eager bidders. Right, so the 3x return was in the bag. Wait…still reading. What? No return on equity? What cruel fate the gods have written. No man, no A-Team, not even Mr. T could withstand that twist of fate!
At least the transaction was “arms length.” Thank goodness for that. I mean of all the things that could have happened, at least you had the good fortune to capture and report back on an arms-length transaction. I am sure the skeptics don’t really know what arms-length really means. And you have the foresight to mention that in this email. Good thinking. That will quash anyone who is thinking any untoward thoughts. By the way, please let us know where you career takes you, where you all land. We trust you, man.
Oh, I get it. This email is a red herring. There is more news on the second, super-secret auction that is the real auction that we couldn’t be told about lest the competition got wind of it! We will wait patiently for our next report on the juicy returns we can expect from the company’s massive progress.
After it is over, really, let us know who those six hungry and enlightened bidders were. I will give you a hint, me and a few liquidators had our hopes dashed because we wanted those servers to post on Craigslist. Those things will go for millions! The original Kadoink servers!!!
Signed,
A Patient and Confident Investor!
Well, at least you know that next time when you’re investing in a company that seeks good leadership, both technical and strategic, you can recommend the top guys at the Kadoink Executive Club (KEC) to the job. After all, bad fate wouldn’t strike twice at the same exact team, would it?
But hey, look at the good side – at least you got a chance to vent off some quality cynicism.
Venture funding always comes with a price tag – that lesson was learned the hard way by lots of folks back in the Dot-Bomb days. Venture funding that’s structured as secured debt can be a time bomb, particularly for a start-up. This is a great example of the importance of caveat mutuor (borrower beware), and of understanding all the moving parts of a venture deal…
Great cautionary tale. I’d love to see more enlightening business articles like this on TC, and fewer updates on Twitter.
stay away from hercules technology group, and manuel!!! he’s evil
Venture debt is often misunderstood. Perhaps because we refer to it as “venture debt” people mistakenly lump it into the same category as venture capital. But it’s not really “ventured” at all; it’s fully secured debt, which means the company is obligated to pay it back.
In other words, once a company no longer foresees the ability to pay back the loan (either by making money, or raising a new round of capital) it enters a “Zone of Insolvency” where the company is obligated to do whatever is best to pay the loan off (which is often shutting down and selling off the assets).
Truth is, venture debt really only makes sense in situations where a company will be able to rapidly grown its value (and raise additional funding) or quickly generate a revenue stream. Given how much harder it is becoming to do rounds offinancing now, venture debt deals make very little sense because of the obligation they bring.
Moral of the the story is that startup shouldn’t be taking on debt that they cannot realistically afford to pay back. And debt without the ability to seize assets is called “equity”, not debt or venture debt.
Here the equity guys stopped funding as well and at least didn’t care enough to take out Hercules (which makes sense ‘coz even hercules lost $ on the sale).
Isn’t bankruptcy the same thing as running out of money?
Leaving spin aside, Isn’t the real story that kadoink failed to deliver and was headed for the deadpool anyway? Many startups fail.
And if the vcs won’t finance the company in a downside, why would anyone expect its lender to finance it?
founders took $4.5 million off the table? left everyone else holding the bag then. set company up for failure. $4.5 gone looks like it forced company to take on debt financing at the expense of the company. who gets to take $4.5M off the table out of a $9.5 history of funding? vc’s asleep at the wheel here. founders laughing to the bank
Stefan, nope, you got it wrong. The founders were paid to get lost out of funds from the VC directly, not the company. i.e. the company never lost a dime in the “kill the founders” transaction.
i.e. the VC’s bought the founders out directly. No cash came out of the company.
In other words, they sold out directly to the VC without affecting the corporate coffers.
Hercules is a good company. This is not a sub-prime mortgage shady deal. They offer a service that makes a lot of sense for many VC-backed companies. These guys didn’t fail because of venture debt, in fact, they would have failed sooner without it. Blaming the debt is uninformed.
The money-off-the-table comment by the founders seems unlikely. What most VC’s do in such a situation is buy the founder shares directly. It’s not money out of the company account, its just a bet by the VC to buy more equity for cheap.
This does happen from time to time. I’ll bet it was what happened here.
It’s no fun to wind-up operations….and, boy, do the accusations fly.
To the angels, Its unfortunate you got tagged with incompetent leadership and a even more incompetent VC who did not see this coming and backed the wrong donkey.
After all, who is a bigger ass: the donkey or those who follow it…
It will now only be a what-if speculation: “What if the VC’s did not decide to back the CEO and kick the founders out of the company they created.”.
Yes, the founders walked out with a good deal of money, but as told – it was paid not by the company, but by the VC, who was certain he’s getting rid of some loose cannons, while all the time he was strapped on to the biggest loose cannon ever in the form of the CEO. Ass follows ass…
Was that debt REALLY necessary? No!
Did they REALLY need a huge office space? Absolutely not!
Did they need more management than sense? Nope!
Did they need to outsource all, change the product and technology? Not at all!
I would have buried myself in the Arizona desert for a few years if I had to send such a letter to investors. I would have been so ashamed of myself I would have changed my identity and had plastic surgery to alter my ugly face. I would have become a burger flipper at McD, a roadie for ZZ top, a male stripper or a street entertainer and never touch exec jobs ever again. Out of shame. That ‘ HAHA screw you’ letter is anything but that. Its a ‘HAHA screw you’ letter
…interesting back and forth on this one. One writer commented that borrowers should only take debt where the only event of default is non-payment. I will just add that venture debt loans have historically been extremely under collateralized with terms so generous that they deserve a MAC (material adverse change) clause. Venture leasing or debt secured against only the company’s fixed assets generally should not include a MAC clause. I run an equipment leasing fund and we finance venture stage companies and I generally agree with what the writer implied – which is that companies can finance their fixed assets without facing a MAC clause.
To Ratpointer-
Obivious from your words, and your interesting choice of names for yourself you are not the kind of man that would own up to your mistakes and personally face those you let down.
I am assuming that you are, in fact, flipping burgers now (you are already in hiding, Im not sure if you have yourself taken up stripping?)
You are pointing out the obvious of 20/20 hindsight.
Maybe you should also tell us that the market was going to crash last year. Where was your expertise when we ALL needed it?
It is obvious you have a personal issue here. Maybe you should see a shrink instead of Tech Crunch? Just an idea.