Thread by @dunkhippo33

A tweet thread about debt vs equity since that seems to be a hot topic these days. cc @joshmuccio

1) First, what do these terms even mean? What does it mean to be a debt investor vs an equity investor?

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@joshmuccio 2) Equity investors: (such as VCs) will give a company $x in exchange for a percentage of the company.

So say I invest $100 in your company in return for 10% of your co. If you sell your co for $10,000, then I make $1000 and have 10xed my investment.

@joshmuccio 3) Debt investors: will give a company $x and are looking to be paid back $x + some interest later.

So say I invest $100 in your company and ask for 10% interest and want to repaid in a year, you will send me $110 in a year, and I would have made $10.

@joshmuccio 4) There's a LOT of back and forth on whether debt or equity is "good" or "bad" these days.

@Alex_Danco wrote an interesting post last wkend on the coming of debt that I highly recommend reading. alexdanco.com/2020/02/07/deb…

the tl;dr is will debt disrupt VCs to some extent?

@joshmuccio @Alex_Danco 5) @Jason countered by saying the debt is a horrible idea for startups.

Who is right?

@joshmuccio @Alex_Danco @Jason 6) Like everything else, it depends...

But let's break this down. And let's make this simpler. Let's say that you're a 4th year med student about to graduate. I offer to pay all your loans off in exchange for 50% of your earnings for eternity. Would you take the deal?

@joshmuccio @Alex_Danco @Jason 7) Probably not. This is equiv to an equity offer. It's a near slam dunk you are about to make a boatload of money, & I will make several multiples my investment. There's little risk here. You'd probably prefer to take out a student loan.

@joshmuccio @Alex_Danco @Jason 8) Ok, now let's say you're a 1st grader. You don't come from wealth. And I make you the same offer - I will pay for all of your private schooling if you can get in through med school in exchange for 50% of your salary forever. Would you take it?

@joshmuccio @Alex_Danco @Jason 9) Maybe. There's a lot of risk ahead and this might be a good deal for you to change your career trajectory by not having to worry about paying for expensive schools.

@joshmuccio @Alex_Danco @Jason 10) So just using personal examples alone, we see that our interest in taking an equity deal or a debt deal is based on how risky an outcome is and what our cost of capital will be. And that's exactly the right way to think about debt and equity.

@joshmuccio @Alex_Danco @Jason 11) In general, you want to take equity when things are quite risky / not guaranteed of working. And you want to take debt when you just need working capital but it's a near slam dunk you are going to be able to use money to make money immediately.

@joshmuccio @Alex_Danco @Jason 12) This is a pretty good primer that folks should read: medium.com/@dereklbittar/…

@joshmuccio @Alex_Danco @Jason 13) So let's say we are starting a co. We have no revenue. We don't know our business model. In this case, we'd rather take an equity deal, because we probably won't even quality for any debt providers or the interest will be too ridiculous to compensate for their risk.

@joshmuccio @Alex_Danco @Jason 14) Now let's say our company is growing up. And we have a strong sense that if we put $1 into ads, it will produce $2 in new revenue. We should take some debt to fund this cust acq. We KNOW we can pay it back and this capital will be cheaper than equity to grow the biz.

@joshmuccio @Alex_Danco @Jason 15) If you want to run through the #s between debt and equity, check out my blog post here: elizabethyin.com/2019/07/19/how…

The difference for many startups who have repeatable revenue could be on the order of millions of dollars. But most ppl don't think about that.

@joshmuccio @Alex_Danco @Jason 16) In addition, debt can also help w/ cash flow. E.g. say you get paid $100 90 days later by your suppliers. You are out $100 for the next 90 days. Wouldn't you rather take $95 now and put that to work now to make more money than wait? A debt provider will do that for you.

@joshmuccio @Alex_Danco @Jason 17) The other thing that most ppl don't realize is that debt comes in many forms. The type of debt most ppl are familiar with is cc debt. And from either personal experience or what friends say, ppl always say "Ooooh cc debt is bad!" And it largely is! But that's not all debt.

@joshmuccio @Alex_Danco @Jason 18) But debt for companies comes in many forms. For example, Brex, for ex offers no interest for 60 days. That's literally free cash that you can use for 60 days to fund more marketing. And all their competitors are trying to do similar things.

@joshmuccio @Alex_Danco @Jason 19) There's also revenue-based financing. This isn't time based debt. Time based debt is where you have pay back your loan + interest by a certain date. But revenue based financing works with you during the highs and the lows.

@joshmuccio @Alex_Danco @Jason 20) E.g. You still pay back a fixed amount (loan + interest) but you pay back a fixed percentage of your revenue until you fully pay it back. So if sales are really slow, you may not end up paying it back for 5 years. This kind of debt works with you not against you.

@joshmuccio @Alex_Danco @Jason 21) tl;dr Equity $$ is good for starting a co. But you'll want to think about taking on even $10k-$100k debt at the post-seed stage as you get confidence in the repeatability of your cust acq. It's far cheaper capital & you can make millions more in the end just w/ this 1 change.