Junk Bonds for Startups

Cover of "Liar's Poker"
Cover of Liar's Poker

After reading Michael Lewis’ latest book, The Big Short, this weekend it got me thinking more about junk bonds. Michael Lewis referenced his first book, Liar’s Poker, which chronicles the rise of the junk bond industry at Solomon Brothers, several times in the new book. Ted Turner’s autobiography, Call me Ted, talks about how junk bonds were the only way he could finance the growth of his empire without giving up control of his namesake business.

Why don’t we see the equivalent of a junk bond industry for startups?

Financing for startups typically revolves around angel investors (three Fs – friends, family, and fools) and venture capitalists with the occasional bootstrapper thrown in. I don’t see junk bonds working for pre-revenue companies as bonds are predicated on the ability to pay interest as well repay the whole amount at maturity. But for startups that have moved from the seed stage to early or growth stage (e.g. at least $1 million in revenue), knowing the gross margins for software and SaaS companies are typically north of 70%, there should be opportunity for junk bonds (e.g. high interest loans) to finance growth. The bonds would be senior debt such that failure to repay or refinance the bonds would potentially turn ownership of the company over to the bond holders, there’s sufficient collateral in the form of company equity to back the financing.

Here are a few reasons why we don’t see a junk bond market for startups:

  • Reporting, auditing, and other controls for startups are typically weak giving little transparency to potential financiers
  • Many technology startups that reach $1 million in revenue already have investors and are on the investor train (e.g. once you raise institutional money, and things are going well, you’re going to likely raise more and more rounds of equity financing)
  • There are so few startups looking for this type of financing that connecting the buyers and sellers would be prohibitively expensive

We’re not going to see a junk bond market for startups anytime soon but I believe there’s a need in the market for profitable, fast-growing startups to be able raise debt financing without collateral (e.g. real estate or physical assets) backing it up.

What do you think? Is there a market for startups to do debt financing with asset-lite businesses?

4 thoughts on “Junk Bonds for Startups

  1. We currently use a LOC that is backed by our receivables from a company called Allied Financial Corp and they make money very quickly available to us as rapidly as the receivable asset base is growing. This line has to be personally backed and the business must have strong margins but this is an excellent financing vehicle outside of traditional angels or banks who are super super conservative these days (don’t expect anything from them, or if you do it will be minor). This alternative financing route is a very reasonable financing instrument for a rapidly growing business with strong receivables and consistent/acceleratee growth trajectory and good business margins. In this scenario no equity is given up. Also, sometimes a similar arrangement can be made with friends, family and investors looking for a higher yield loan vs an equity arrangement but will require more work to get established. No audit is required for the AR backed LOC and the process was very fast.

  2. Two biggest hurdles IMHO to debt financing (apart from receivables financing) for web-based startups are absence of hard assets to serve as collateral and uncertainty of future cash flow to service the debt.
    Awesome daily blog, David! Do you think you will ever amount to anything as an entrepreneur? 😉

  3. @At David Cummings, how do you feel about this topic today? Uber and WeWork have both issued bonds for example. Startups are delaying their IPO more and more increasing their need for pre-IPO capital. Do you think the market has become ripe for mature startup debt financing?

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