http://www.paulgraham.com/swan.html); venture debt investors expect to get repaid on every investment. With venture debt investors, repayment is contractually required: every cent must be repaid. Venture debt investors typically tie their investment to business plan milestones, metrics like accounts receivable and revenue, or events, whereas most equity investors allow startups leeway to pivot. Unlike equity investors, venture debt investors are less flexible. These investors are not as concerned with reputational damage: while an equity investor may support a startup that “pivots” to find product market fit, a venture debt investor is less understanding, given the need to get repaid. Venture debt lenders are thus more apt to enforce a contract to make sure their money is returned, even if the company would be killed from such enforcement. These investors are myopically focused on losing as little money as possible; they rarely are interested in any other considerations.</p>\n<h2>Strategy: How to Approach Venture Debt</h2>\n<p>First, founders need to understand basic venture debt terminology. Founders do not need to be venture debt experts, but do need to understand their contractual obligations, particularly because venture debt lenders will rely on these contractual terms to protect their investment<a id=\"footnote1a\"><a href=https://www.ycombinator.com/"#footnote1\"><b><sup>1</sup></b></a></a>. Founders need to assess which terms are important, and which ones may place their company at risk. At the bottom of this essay is a short glossary and explanation of some key terms that founders will encounter in a venture debt financing.</p>\n<p>Second, after understanding the basics, founders should consider evaluating multiple venture debt lenders in order to make the process competitive. Far too often, Y Combinator founders tell me that they met a venture debt lender, got a term sheet and quickly signed and agreed to terms. A founder would never speak to only one equity investor when raising a Series A round, but in my experience, it is common for founders to speak to only one venture debt investor. Fortunately, there are more lenders and new entrants offering venture debt, and founders now have additional options (more on this topic below). Working with a more friendly lender that you know well can make all the difference in a downside case, but you also should not drag on the venture debt raise process for months – you have a business to run.</p>\n<p>Third, founders must involve legal counsel when entering into a venture debt relationship. Again, the terms and conditions of venture debt financings arguably matter more than equity financings because lenders do not hesitate to assert their rights and will apply assertive tactics to recover every dollar they can. For example, there are important differences in the types of “defaults” that may trigger a loan to be due immediately, and experienced counsel will help protect a company and make sure that it is better positioned if things go awry. Often a startup involves counsel after a term sheet is signed, but it is better to involve counsel earlier in the process, which typically is when a company has more leverage.</p>\n<p>Please note that while venture debt investors need to protect their investment, they also deserve to be treated fairly. There are many instances where venture lenders have complained that companies were not forthcoming about their circumstances and did not provide relevant information such as their cash burn, or the loss of a significant lost contract. It does not help a company to hide from its lenders – the worst possible way to treat your lender is to make them think that everything is going according to plan, and then drop a bombshell on them when it’s too late to course-correct. Because there may be ways to restructure debt, it inures to a company’s benefit to treat its lenders fairly.</p>\n<h2>Good news: New Entrant: Brex</h2>\n<p>I mentioned there are new entrants in the venture debt space, and Y Combinator is glad that our portfolio company Brex is now offering venture debt financings to startup companies. Understanding startups’ financial needs is in Brex’s DNA: the company grew quickly because it understood the challenges startups had with accessing basic credit. Brex knows how to serve startups and young companies with a variety of credit solutions and is a welcome addition to this market. YC has shared our concerns with Brex about the pitfalls of venture debt, and Brex has plans to make its venture debt financing terms simple and transparent. While we are confident in Brex’s ability to compete in any market, we continue to believe that all startups should reach out to multiple parties when accessing venture debt. To learn more about Brex’s offering, see <b><a href=https://www.ycombinator.com/"https://www.brex.com/product/venture-debt//">here.

/n

Conclusion:

/n

Venture debt clearly has many benefits &#8212; it offers startups a less dilutive way to inject capital into a healthy, growing business, a business that most traditional banks ignore today. At its best, venture debt is an effective complement to equity financing, and helps accelerate a company’s growth. But accessing venture debt is not without risks<a id=\"footnote2a\"><a href=https://www.ycombinator.com/"#footnote2\"><sup><b>2</b></sup></a></a>. Founders should be realistic and ask themselves whether they are taking on a burden that can be repaid. A company is best positioned to assume venture debt when it is confident in its ability to repay the loan, which will eliminate all associated risks.</p>\n<h3>GLOSSARY: BASIC TERMINOLOGY (for familiarity only; counsel needs to be hired):</h3>\n<p><u>Commitment</u>: What type of commitment is your venture debt investor making? How much money is being offered? When can your company access the money? Does the company need to “draw-down” over time? Can the company access all the capital at once?</p>\n<p><u>Term Loan/ Revolver</u>: Term loans are for a set time period (i.e. 3 years) and have a fixed payment schedule. The payment schedule can be “amortized” meaning that both the principal and interest is paid through periodic payments e.g. a mortgage; a “bullet” payment means the interest payment is made throughout and the principal is paid at the end of the term (aka the “maturity” date).</p>\n<p>Revolvers are like credit cards or a line of credit: a borrowing limit is set by the lender. Most venture lenders charge a “commitment fee” – the fee can be a flat fee or a fixed percentage of the commitment and is intended to compensate the lender for keeping open access to the money. Make sure to understand how much money is being paid on fees: venture lenders tend to nickel and dime companies with tiny fees.</p>\n<p><u>Interest Rate</u>: Interest rate is a crucial term and varies on a company’s ability to repay; the rate may vary from ~6-10%. Term sheets often express interest as “Prime rate plus x%”. Many lenders offer an interest only period prior to requiring repayment of principal.</p>\n<p><u>Warrants</u>: Warrants are another critical term and provide the lender with potential upside as a stockholder in a venture backed company. Warrants are typically a percentage of the commitment (i.e. 5% of $2mm). Most lenders ask for preferred stock based on a company’s last round, but an increasing amount of recent term sheets request a set percentage of common stock. Obviously, it is important to speak to multiple lenders when negotiating interest rates and warrant coverage.</p>\n<p><u>Prepayment Penalties</u>: Founders should make sure there are no charges for paying back their loan early (can be very useful if the market improves).</p>\n<p><u>Investor Abandonment</u>: A clause that allows the lender to demand repayment if a company’s investor doesn’t invest in the company’s future round.</p>\n<p><u>Negative Pledge on IP</u>: A clause that prevents a company from pledging its intellectual property to another party while the loan is outstanding. Sometimes lenders ask for a first-priority security interest on a company’s IP &#8212; this is a term companies should not accept.</p>\n<p><u>Field exams/ legal costs</u>: Beware of hidden fees! Look for clauses that allow the lender to conduct on site exams (at the company’s expense). Make sure to cap legal fees and do not pay the lender for documents that have been drafted a hundred times.</p>\n<p><u>Current Ratio/ Quick Ratio</u>: These financial terms measure a company’s liquidity and may impact how large a commitment a lender makes. The “current ratio” measures a company’s assets by dividing the company’s assets by the amount of liabilities. The “quick ratio” only includes the most liquid current assets that can be turned to cash quickly, and does not include inventory, supplies, etc. Venture debt lenders often use these ratios in covenants to monitor liquidity.</p>\n<p><u>Default Provisions</u>: Defaulting on a loan allows the lender to ask for its money back and can kill a company. There are different types of defaults in venture loan contracts: technical default (violating a covenant); monetary default (missing a payment); change in status default (legal judgment); and there are subjective defaults: “material adverse change” or “investor abandonment”. It is important to maintain a good relationship with your lender, especially if there is a subjective default provision that may be triggered. In these circumstances, a lender bank may choose to revise its debt, or make the more draconian decision to send the loan to its bank’s workout group.</p>\n<hr />\n<p><a id=\"footnote1\"><a href=https://www.ycombinator.com/"#footnote1a\"><sup><b>1</b></sup></a></a> Venture debt terms and concepts are very simple; the language may seem daunting because it is unfamiliar. The dynamic is similar to equity financings: it is disconcerting for founders when they first hear preferred stock financing terminology (e.g. liquidation preference, broad-based weighted average anti-dilution, right of first refusal and co-sale rights). But all YC founders quickly get up to speed and understand the meaning of these simple concepts. Venture debt terminology may seem unfamiliar, but also can be understood quickly.</p>\n<p><a id=\"footnote2\"><a href=https://www.ycombinator.com/"#footnote2a\"><sup><b>2</b></sup></a></a> I have not listed all the risks associated with venture debt. It is important to note that unlike equity, venture debt requires a startup to agree to financial “covenants” &#8212; e.g. a startup needs approval before incurring additional indebtedness, selling assets, etc.. More important, in a downside scenario, a venture lender often influences a company’s ultimate exit. That means if a company is running out of capital and has two options, one which employees prefer and one which is better for the bank, the company probably will have to choose the option that is better for the bank. These risks further highlight why founders need to be realistic about their ability to repay. To emphasize, founders should remember that venture debt is a debt that needs to be paid back.</p>\n<!--kg-card-end: html-->","comment_id":"1104897","feature_image":"/blog/content/images/2022/02/BlogTwitter-Image-Template-1--1-.png","featured":false,"visibility":"public","email_recipient_filter":"none","created_at":"2021-08-26T01:59:44.000-07:00","updated_at":"2022-02-03T16:34:50.000-08:00","published_at":"2021-08-26T01:59:44.000-07:00","custom_excerpt":"In this guide, YC Managing Director Jon Levy talks about venture debt. He covers what it is, walks through some of its benefits and risks, and gives advice on how to approach the process of taking on venture debt.","codeinjection_head":null,"codeinjection_foot":null,"custom_template":null,"canonical_url":null,"authors":[{"id":"61fe29e3c7139e0001a7109c","name":"Jon Levy","slug":"jon-levy","profile_image":"/blog/content/images/2022/02/jon.jpg","cover_image":null,"bio":"Jon is Managing Director, Partnerships at Y Combinator. He previously counseled public and private technology companies as an attorney for Wilson Sonsini Goodrich and Rosati.","website":null,"location":null,"facebook":null,"twitter":null,"meta_title":null,"meta_description":null,"url":"https://ghost.prod.ycinside.com/author/jon-levy/"}],"tags":[{"id":"61fe29efc7139e0001a71174","name":"Advice","slug":"advice","description":null,"feature_image":null,"visibility":"public","og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"codeinjection_head":null,"codeinjection_foot":null,"canonical_url":null,"accent_color":null,"url":"https://ghost.prod.ycinside.com/tag/advice/"},{"id":"61fe29efc7139e0001a7116d","name":"Essay","slug":"essay","description":null,"feature_image":null,"visibility":"public","og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"codeinjection_head":null,"codeinjection_foot":null,"canonical_url":null,"accent_color":null,"url":"https://ghost.prod.ycinside.com/tag/essay/"},{"id":"61fe29efc7139e0001a71170","name":"Startups","slug":"startups","description":null,"feature_image":null,"visibility":"public","og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"codeinjection_head":null,"codeinjection_foot":null,"canonical_url":null,"accent_color":null,"url":"https://ghost.prod.ycinside.com/tag/startups/"}],"primary_author":{"id":"61fe29e3c7139e0001a7109c","name":"Jon Levy","slug":"jon-levy","profile_image":"https://ghost.prod.ycinside.com/content/images/2022/02/jon.jpg","cover_image":null,"bio":"Jon is Managing Director, Partnerships at Y Combinator. He previously counseled public and private technology companies as an attorney for Wilson Sonsini Goodrich and Rosati.","website":null,"location":null,"facebook":null,"twitter":null,"meta_title":null,"meta_description":null,"url":"https://ghost.prod.ycinside.com/author/jon-levy/"},"primary_tag":{"id":"61fe29efc7139e0001a71174","name":"Advice","slug":"advice","description":null,"feature_image":null,"visibility":"public","og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"codeinjection_head":null,"codeinjection_foot":null,"canonical_url":null,"accent_color":null,"url":"https://ghost.prod.ycinside.com/tag/advice/"},"url":"https://ghost.prod.ycinside.com/venture-debt-101-basics-and-approach/","excerpt":"In this guide, YC Managing Director Jon Levy talks about venture debt. He covers what it is, walks through some of its benefits and risks, and gives advice on how to approach the process of taking on venture debt.","reading_time":8,"access":true,"og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"email_subject":null,"frontmatter":null,"feature_image_alt":null,"feature_image_caption":null},"mentions":[],"related_posts":[{"id":"620da5f7d710a50001fba7dd","uuid":"2e869860-9ab1-45e5-9761-e49ec49f7a45","title":"Y Combinator Top Companies - February 2022","slug":"y-combinator-top-companies-feb-2022","html":"<!--kg-card-begin: markdown--><p>We’re excited to share the <a href=https://www.ycombinator.com/"https://www.ycombinator.com/topcompanies/">2022 YC Top Companies</a>. In addition to the list of top companies, we also launched the <a href=https://www.ycombinator.com/"https://www.ycombinator.com/topcompanies/breakthrough/">YC Breakthrough Companies</a> list to highlight the fast-growing companies that have received between $15M-$300M <a href=https://www.ycombinator.com/"https://www.ycombinator.com/continuity//">from YC</a>.</p>\n<p>Both lists include private, public and exited companies valued at $150M or more and are sorted by valuation<sup class=\"footnote-ref\"><a href=https://www.ycombinator.com/"#fn1\" id=\"fnref1\">[1]</a></sup> or market cap as of February 2022.</p>\n<p>Here are some stats about this year’s list:</p>\n<ul>\n<li>\n<p>More than 260 YC companies are valued at $150M+ and more than 60 companies are valued at $1B+.</p>\n</li>\n<li>\n<p>99 new companies joined the list since our last update in July 2021.</p>\n</li>\n<li>\n<p>More companies are operating remotely</p>\n<ul>\n<li>11% of the top companies are remote first.</li>\n<li>Three of the top ten private companies are remote first (<a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/opensea/">OpenSea, <a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/brex/">Brex, <a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/gitlab/">Gitlab)./n/n/n

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    20 countries are represented</p>\n<ul>\n<li>6 new countries represented: Algeria, Tunisia, Senegal, Chile, Brazil, and Singapore</li>\n<li>Of the companies that are new to the list, 28% are outside of the US.</li>\n</ul>\n</li>\n<li>\n<p>Top 10 valuation jumps since July 2021:</p>\n<ul>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/flock-safety/">Flock Safety</a> (jumped 74 spots to #31)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/solugen/">Solugen (jumped 74 spots to #51)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/gem/">Gem (jumped 69 spots to #76)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/modern-treasury/">Modern Treasury</a> (jumped 52 spots to #48)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/xendit/">Xendit (jumped 49 spots to #37)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/captivateiq/">CaptivateIQ (jumped 35 spots to #71)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/easypost/">EasyPost (jumped 34 spots to #60)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/h1/">H1 (jumped 30 spots to #98)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/veriff/">Veriff (jumped 28 spots to #61)</li>\n<li><a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/promise/">Promise (jumped 21 spots to #121)</li>\n</ul>\n</li>\n</ul>\n<p>You can read more about some of the featured companies <a href=https://www.ycombinator.com/"https://www.ycombinator.com/topcompanies/featured/">here.

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    One thing to note is that this is not an exhaustive list of YC’s top companies. We allowed founders to opt out of being listed for any reason. Here's the <a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/">full list</a> of YC companies.</p>\n<p>Congratulations to all of the fantastic companies highlighted here. We’re delighted to be part of their stories and hope these lists help potential employees, customers and investors identify companies they’d like to work with as well.<br>\n<br></p>\n<p><em>This list was published in late February 2022, just as the fighting in Ukraine began. We didn’t think it was an appropriate moment to be celebratory, and wanted to take time to turn our attention to <a href=https://www.ycombinator.com/"https://www.ycombinator.com/blog/supporting-ukraine/">the Ukrainian people</a> and the YC community being impacted by the invasion of Ukraine.</em><br>\n<br></p>\n<hr class=\"footnotes-sep\">\n<section class=\"footnotes\">\n<ol class=\"footnotes-list\">\n<li id=\"fn1\" class=\"footnote-item\"><p>Why do we use valuation? We have always said that valuation is not the best way to measure a company’s value, and we consistently warn our companies not to over-optimize their fundraising for a high valuation. That said, it’s the most commonly available metric to compare companies in the startup world. Other metrics, like revenue, are often kept private. We have a number of impressive companies who would appear on the list or rank even higher if we counted other metrics (revenue, revenue/employee, etc). <a href=https://www.ycombinator.com/"#fnref1\" class=\"footnote-backref\">↩︎</a></p>\n</li>\n</ol>\n</section>\n<!--kg-card-end: markdown-->","comment_id":"620da5f7d710a50001fba7dd","feature_image":"/blog/content/images/2022/02/yc-top-companies-list-og-image-2.png","featured":true,"visibility":"public","email_recipient_filter":"none","created_at":"2022-02-16T17:33:43.000-08:00","updated_at":"2022-04-19T16:33:56.000-07:00","published_at":"2022-02-28T08:44:00.000-08:00","custom_excerpt":"We’re excited to share the 2022 YC Top Companies. 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Combinator","slug":"yc","profile_image":"https://ghost.prod.ycinside.com/content/images/2022/02/yc.png","cover_image":null,"bio":null,"website":null,"location":null,"facebook":null,"twitter":null,"meta_title":null,"meta_description":null,"url":"https://ghost.prod.ycinside.com/author/yc/"},"primary_tag":{"id":"61fe29efc7139e0001a71173","name":"YC News","slug":"yc-news","description":null,"feature_image":null,"visibility":"public","og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"codeinjection_head":null,"codeinjection_foot":null,"canonical_url":null,"accent_color":null,"url":"https://ghost.prod.ycinside.com/tag/yc-news/"},"url":"https://ghost.prod.ycinside.com/y-combinator-top-companies-feb-2022/","excerpt":"We’re excited to share the 2022 YC Top Companies. In addition to the list of top companies, we also launched the YC Breakthrough Companies list to highlight the fast-growing companies that have received between $15M-$300M from YC.","reading_time":2,"access":true,"og_image":null,"og_title":null,"og_description":null,"twitter_image":null,"twitter_title":null,"twitter_description":null,"meta_title":null,"meta_description":null,"email_subject":null,"frontmatter":null,"feature_image_alt":"Y Combinator Top Companies - February 2022","feature_image_caption":null},{"id":"62fa7b87ab52db0001d3b656","uuid":"c432a242-4288-4980-a6e9-d9c82359c9ad","title":"YC Founder Firesides: Gusto on building for new verticals","slug":"yc-founder-firesides-gusto-on-building-for-new-verticals","html":"<p><a href=https://www.ycombinator.com/"https://gusto.com//">Gusto (<a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/gusto/">YC W12</a>) provides growing businesses with everything to take care of their team. Today, more than 200,000 businesses use Gusto for payroll, employee benefits, talent management, and more. And with the recent addition of <a href=https://www.ycombinator.com/"https://embedded.gusto.com//">Gusto Embedded</a>, developers now use Gusto’s APIs and pre-build UI  flows to embed payroll, tax filing, and payments infrastructure into products. </p><p>Last week, Gusto <a href=https://www.ycombinator.com/"https://gusto.com/company-news/gusto-embedded-one-year-in-fueling-smb-tech-success-at-scale-with-critical-compliance-/">announced they have dozens of new partners across verticals like laundromats, health &amp; beauty, and construction building with Gusto Embedded. The company also announced they are making it easier for software providers to keep their payroll customers in compliance.</p><p>YC’s <a href=https://www.ycombinator.com/"https://twitter.com/anuhariharan/status/1557784730543632384/">Anu Hariharan</a> sat down with Gusto co-founder and CPO <a href=https://www.ycombinator.com/"https://twitter.com/tomerlondon/">Tomer London</a> to talk about building for new customer segments and the future of embedded finance — sharing advice for startup founders and CEOs along the way. </p><div class=\"kg-card kg-audio-card\"><img src=https://www.ycombinator.com/"https://ghost.prod.ycinside.com/content/media/2022/08/Founder-Fireside---Tomer-London--Gusto-_thumb.jpg?v&#x3D;1660587475243\" alt=\"audio-thumbnail\" class=\"kg-audio-thumbnail\"><div class=\"kg-audio-thumbnail placeholder kg-audio-hide\"><svg width=\"24\" height=\"24\" fill=\"none\" xmlns=\"http://www.w3.org/2000/svg\"><path fill-rule=\"evenodd\" clip-rule=\"evenodd\" d=\"M7.5 15.33a.75.75 0 1 0 0 1.5.75.75 0 0 0 0-1.5Zm-2.25.75a2.25 2.25 0 1 1 4.5 0 2.25 2.25 0 0 1-4.5 0ZM15 13.83a.75.75 0 1 0 0 1.5.75.75 0 0 0 0-1.5Zm-2.25.75a2.25 2.25 0 1 1 4.5 0 2.25 2.25 0 0 1-4.5 0Z\"/><path fill-rule=\"evenodd\" clip-rule=\"evenodd\" d=\"M14.486 6.81A2.25 2.25 0 0 1 17.25 9v5.579a.75.75 0 0 1-1.5 0v-5.58a.75.75 0 0 0-.932-.727.755.755 0 0 1-.059.013l-4.465.744a.75.75 0 0 0-.544.72v6.33a.75.75 0 0 1-1.5 0v-6.33a2.25 2.25 0 0 1 1.763-2.194l4.473-.746Z\"/><path fill-rule=\"evenodd\" clip-rule=\"evenodd\" d=\"M3 1.5a.75.75 0 0 0-.75.75v19.5a.75.75 0 0 0 .75.75h18a.75.75 0 0 0 .75-.75V5.133a.75.75 0 0 0-.225-.535l-.002-.002-3-2.883A.75.75 0 0 0 18 1.5H3ZM1.409.659A2.25 2.25 0 0 1 3 0h15a2.25 2.25 0 0 1 1.568.637l.003.002 3 2.883a2.25 2.25 0 0 1 .679 1.61V21.75A2.25 2.25 0 0 1 21 24H3a2.25 2.25 0 0 1-2.25-2.25V2.25c0-.597.237-1.169.659-1.591Z\"/></svg></div><div class=\"kg-audio-player-container\"><audio src=https://www.ycombinator.com/"https://ghost.prod.ycinside.com/content/media/2022/08/Founder-Fireside---Tomer-London--Gusto-.mp3/" preload=\"metadata\"></audio><div class=\"kg-audio-title\">Founder Firesides: Gusto&#x27;s Tomer London on building for new verticals</div><div class=\"kg-audio-player\"><button class=\"kg-audio-play-icon\"><svg xmlns=\"http://www.w3.org/2000/svg\" viewBox=\"0 0 24 24\"><path d=\"M23.14 10.608 2.253.164A1.559 1.559 0 0 0 0 1.557v20.887a1.558 1.558 0 0 0 2.253 1.392L23.14 13.393a1.557 1.557 0 0 0 0-2.785Z\"/></svg></button><button class=\"kg-audio-pause-icon kg-audio-hide\"><svg xmlns=\"http://www.w3.org/2000/svg\" viewBox=\"0 0 24 24\"><rect x=\"3\" y=\"1\" width=\"7\" height=\"22\" rx=\"1.5\" ry=\"1.5\"/><rect x=\"14\" y=\"1\" width=\"7\" height=\"22\" rx=\"1.5\" ry=\"1.5\"/></svg></button><span class=\"kg-audio-current-time\">0:00</span><div class=\"kg-audio-time\">/<span class=\"kg-audio-duration\">118:07</span></div><input type=\"range\" class=\"kg-audio-seek-slider\" max=\"100\" value=\"0\"><button class=\"kg-audio-playback-rate\">1&#215;</button><button class=\"kg-audio-unmute-icon\"><svg xmlns=\"http://www.w3.org/2000/svg\" viewBox=\"0 0 24 24\"><path d=\"M15.189 2.021a9.728 9.728 0 0 0-7.924 4.85.249.249 0 0 1-.221.133H5.25a3 3 0 0 0-3 3v2a3 3 0 0 0 3 3h1.794a.249.249 0 0 1 .221.133 9.73 9.73 0 0 0 7.924 4.85h.06a1 1 0 0 0 1-1V3.02a1 1 0 0 0-1.06-.998Z\"/></svg></button><button class=\"kg-audio-mute-icon kg-audio-hide\"><svg xmlns=\"http://www.w3.org/2000/svg\" viewBox=\"0 0 24 24\"><path d=\"M16.177 4.3a.248.248 0 0 0 .073-.176v-1.1a1 1 0 0 0-1.061-1 9.728 9.728 0 0 0-7.924 4.85.249.249 0 0 1-.221.133H5.25a3 3 0 0 0-3 3v2a3 3 0 0 0 3 3h.114a.251.251 0 0 0 .177-.073ZM23.707 1.706A1 1 0 0 0 22.293.292l-22 22a1 1 0 0 0 0 1.414l.009.009a1 1 0 0 0 1.405-.009l6.63-6.631A.251.251 0 0 1 8.515 17a.245.245 0 0 1 .177.075 10.081 10.081 0 0 0 6.5 2.92 1 1 0 0 0 1.061-1V9.266a.247.247 0 0 1 .073-.176Z\"/></svg></button><input type=\"range\" class=\"kg-audio-volume-slider\" max=\"100\" value=\"100\"></div></div></div><p>You can also listen on <a href=https://www.ycombinator.com/"https://open.spotify.com/episode/0FTnE08QzuCg6I21S4PB8e?si=ShDfsjwnRWKYH0LjwzI-rg\%22>Spotify, <a href=https://www.ycombinator.com/"https://podcasts.apple.com/us/podcast/159-yc-founder-firesides-gusto-on-building-for-new/id1236907421?i=1000576161014\%22>Apple Podcasts</a>, and <a href=https://www.ycombinator.com/"https://twitter.com/i/spaces/1dRKZldrvOzJB?s=20\%22>Twitter.

    1:28 - Tomer describes Gusto Embedded and the complexities behind compliance.</p><ul><li>Gusto Embedded takes ten years of Gusto’s experience building payroll software and compliance and makes it available to any software company wanting to ship their own payroll product to the market. </li></ul><p><strong>5:00 </strong>- Why did you decide to pursue startups as the company’s first target audience? How did you think about customer segments in that first year? </p><p><em>Over the last ten years, Gusto has scaled to build for multiple customer segments – starting with startups, then SMBs, accountants, and now with Gusto Embedded Payroll, developers who are embedding payroll directly into their software. </em></p><ul><li>When you have a grand vision, where do you start as a founder? Choose a customer segment. Make sure you choose a segment where 1) they have an important customer problem, 2) the product you are building solves that problem, and 3) you can reach your customer. </li></ul><p><strong>9:30 </strong>- Who were your competitors in the early days? </p><ul><li>The old, traditional payroll solutions, which were complex. With Gusto, <em>anyone</em> can run payroll at <em>any time</em>. Gusto also focuses on employees, a critical part of the system, by building a great payroll experience for them. </li></ul><p><strong>11:30 </strong>- Why did you decide to build for SMBs after startups? </p><ul><li>Look at your current customer base and learn from customers adjacent to the market you want to expand into. When you do expand into another vertical, make sure you maintain that early customer love.  </li></ul><p><strong>14:45</strong> - How did you maintain the customer love of the existing customer segment? </p><ul><li>Think about your long-term vision and don’t put yourself in a corner when you want to move to the next segment. </li></ul><p><strong>17:00</strong> - Most startups find it hard to tackle the SMB market. Why do you think this is the case? </p><ul><li>Traditionally SMBs are hard to reach and use incomplete or manual solutions. Since 2000 an entire generation of business owners had to learn to trust online financial services. Today, SMBs are online and looking for solutions.</li></ul><p><strong>22:25 </strong>- What is different about serving SMBs as a customer versus startups? </p><ul><li>Startups come and go, and the real economics come from the big winners. Focusing on startups is a good place to start your journey, but think about how to scale with them.</li><li>There are more small businesses than startups, and they are around for a long time – but most don’t grow to thousands of employees. You need to build a business model that works with that dynamic. </li></ul><p><strong>27:00 - </strong>Why did you pursue developers and how did you decide to service them? </p><ul><li>For many verticals, it is much better to have an all-in-one platform to run your small businesses. But payroll is really hard to build yourself. Gusto Embedded helps partners deliver a more integrated solution for customers without investing the several years and tens of millions of dollars.</li></ul><p><strong>29:00 </strong>- Gusto went from directly acquiring small businesses as customers to creating an embedded solution – essentially  “giving up” the relationship with the customer. How did you think about that? </p><ul><li>Evaluate the future of the industry and don’t ignore reality. Be the one to create that future. In this case, many payroll customers want all-in-one solutions. We can either try to meet those needs directly, or empower hundreds of partners to customize unique solutions.</li></ul><p><strong>33:00 - </strong>How should founders think about who to partner with? When should founders build directly for the industry and when should they go the embedded route? </p><ul><li>Think about the unique insight you have in the business you’re creating and make sure you own your destiny around that insight.</li><li>For your customer, what does a successful product look like, and could you partner with a company to fulfill those needs.</li><li>Your product must be high-quality. You have to put enough resources behind whatever you own. For everything else, you must ensure you bring in the right partner. It’s all about the end-to-end experience. </li></ul><p><strong>39:30</strong> - Gusto now makes it easier for software providers to bake compliance into embedded payroll. Tomer, I think developers looking at a payroll API would assume that compliance is baked in. But there are often steps companies have to take beyond just calling APIs. Tell us if that assumption holds.</p><ul><li>Regulation can change every quarter and every year. This is built into the product. We protect the customer and make it easy for developers to ship something quickly that is compliant for the long term.</li><li>One third of the companies in the U.S. get fined for mistakes on payroll. </li></ul><p><strong>43:00 - </strong>Compliance is the hardest part of payroll to build and ultimately has to be right. It took ten years of experience in compliance to launch this into Gusto Embedded Payroll. What advice do you have for founders who are building complicated, yet essential, components for an industry?</p><ul><li>Determine the parts of your product that are highly regulated and which areas are not. Build a culture that ensures quality-first in those highly-regulated areas, as well as a culture where people can iterate quickly in other areas. You can’t build a monolithic culture.</li><li>Embrace cross functional work. </li></ul><p><strong>46:00 </strong>- In the early days of Gusto, what guidance did you provide to your engineers about building payroll? What areas could break and which areas could not break? </p><p><strong>48:40</strong> - Looking back, would you have done anything different? </p><ul><li>Start charging what you feel is the value you provide; fix downwards versus upwards. If you’re truly adding value, customers won’t hesitate moving forward at that price.</li><li>Have the humility to learn from the customer and how the market changes around you. </li></ul><p><strong>51:45 </strong>- How should founders be thinking about embedded finance and how does this market evolve over the next 5-10 years? </p><ul><li>When you build a new software system for your customer, the more connected the system is for your customer, the better it is. Embedded products enable you to do that quickly and in high quality.</li><li>Bring more solutions into your product that are driven by what your customer needs. Understand your customer’s day-to-day, and figure out how to build something that solves their entire flow instead of one segment.</li><li>If you are not making money on your product, you don’t know if there's a product market fit. If you can charge and retain a customer, then there is product market fit. </li></ul><p><strong>56:30</strong> - Outside of payroll, what are you seeing product wise offered by APIs? </p><ul><li>This space is brand new and there’s a ton of opportunity to create a product that helps customers go through the end-to-end journey successfully and solves multiple pain points – instead of the customer needing ten years of background to create a high-quality solution.</li></ul>","comment_id":"62fa7b87ab52db0001d3b656","feature_image":"/blog/content/images/2022/08/BlogTwitter-Image-Template--5-.jpg","featured":true,"visibility":"public","email_recipient_filter":"none","created_at":"2022-08-15T09:59:51.000-07:00","updated_at":"2022-08-15T11:48:12.000-07:00","published_at":"2022-08-15T11:32:19.000-07:00","custom_excerpt":"Today, more than 200,000 businesses use Gusto for payroll, employee benefits, talent management, and more. 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You can read the first edition <a href=https://www.ycombinator.com/"https://www.ycombinator.com/blog/learnings-of-a-ceo-max-rhodes-faire/">here. </p><p><a href=https://www.ycombinator.com/"https://zapier.com//">Zapier was founded in 2012 by <a href=https://www.ycombinator.com/"https://twitter.com/wadefoster/">Wade Foster</a>, <a href=https://www.ycombinator.com/"https://twitter.com/bryanhelmig?lang=en\%22>Bryan Helmig</a>, and <a href=https://www.ycombinator.com/"https://twitter.com/mikeknoop/">Mike Knoop</a>. The founders went through YC’s <a href=https://www.ycombinator.com/"https://www.ycombinator.com/companies/zapier/">Summer 2012 batch</a> and <a href=https://www.ycombinator.com/"https://www.ycombinator.com/growth-program/">S18 Growth Program</a>, and today, Zapier automates work by connecting with over 5,000 apps. The company has been profitable since 2014 and is valued at $5B – with 700 employees working remotely. Wade, Zapier CEO, shared his learnings growing into the role of a growth-stage CEO. </p><p><strong>How has your job as a CEO changed from leading a 3-person company in 2012 to a 700-person organization today? </strong></p><p>In the early days, you’re in the trenches with your co-founders and early employees splitting up tasks and touching nearly every part of the business. Often you’re writing code, selling products, recruiting, and helping with HR and finance functions. Today, Zapier is almost a team of 700 – and as we’ve grown, people have taken more and more duties from me to help the company grow and scale.</p><p>Now, one place I feel I am most needed is the vague concept of setting the vision and communicating that vision — and then ensuring everyone understands what we are doing, why it’s important, and their role in getting that done. This came naturally to me when we were small and I was in the trenches with everyone and communicating constantly. But as we hired more folks, I realized leaders were interpreting the vision to their team somewhat differently. I learned that if you are not communicating the vision well, you'll have teams that seem to be working on random projects. In isolation this isn’t bad, but as a collective set of tasks, you discover their work doesn’t fit into the vision. </p><p>We now repeat the vision over and over again in many formats. We put the vision in writing and it's constantly referenced; it's communicated at our all-hands; we bring in customers to talk about Zapier’s impact; we show data, so charts and figures can help tell the story; we have a company podcast. </p><p>When people inside the company start to turn the vision into a meme or Slack emoji, I know they really get the vision. Diagnostic tools, like employee engagement surveys, also help me understand how well employees understand why their role is important. It’s also evident when reviewing roadmaps. If a team’s tasks are tight and cohesive, I can tell they’ve been making tough decisions to align to the vision; if there are a bunch of random tasks, I can tell the vision hasn’t been communicated clearly. As a CEO, you have to ask, “Tell me how this is aligned,” and force those conversations to occur. Over time, people will get more comfortable with these types of assertive exercises. </p><p><strong>As you've grown, what changes have you had to make to keep everyone at your company aligned?</strong></p><p>We host weekly all hands, bring customers in to talk at those all hands, are transparent with metrics, and make sure those metrics are reflective of the good and the bad. Ultra transparency with metrics has served us well, as they are motivating and help people get aligned. People start to ask, \"How do we get these bad metrics to the good category?\" and then work towards change.</p><p>Being candid has also served us well. Whether at all hands, on a podcast, or solely talking with one of our leaders, we have candid conversations about why we didn’t hit a goal, why we were off schedule, why a deal didn’t close – and then immediately dive into what we think needs to happen next. The goal is to give awareness to the organization, so that in various meetings and forums people can try to figure out how to improve those areas.</p><p><strong>What's your advice to other founders on how to hire executives?</strong></p><p>Hiring executives is one of the hardest things you’ll do as a CEO. It's hard to determine when to start hiring executives, exactly what you’re looking for in an executive, and then find that person. </p><p>The best way to figure out when to start hiring executives is to meet with people who are unquestionably good executives at companies a stage or two further along. With no intention to hire them, meet with the VP of Engineering, VP of Marketing, and VP of People and ask, \"What are the things you do? What makes you great at this job? What do people in your job disagree on?”. Get as smart as you can on this topic and then compare and contrast what that set of leaders is telling you with how your company operates. If these executives wouldn’t bring anything new to the table, you may not be ready for that type of leader. This starts to help you answer the when part of the equation – and also the what, because you start to see what these folks are capable of and what they are not. </p><p>Part of determining what you should look for in an executive is understanding your own strengths and weaknesses. This requires honesty with yourself and internalizing feedback you have received. (I encourage folks to work with executive coaches and get 360 performance reviews.) Figuring this out helps you start to realize, \"Okay, within my executive team, I need people who will compliment me in these ways.\" Otherwise, you risk hiring a team that is quite capable and competent at their function, but actually may not work well with each other or with you.</p><p><strong>What is Zapier’s culture? What do you do to cultivate it as a remote company?</strong></p><p>We have a strong set of values that we align around. One is default to action. We hire folks who are action-oriented – and we have to as a distributed company; folks aren’t in situations where they notice someone next to them is stuck on something. So, they need to be curious, self-starters, and (figuratively) scratch and itch when they see something that doesn’t satisfy their innate drive. </p><p>Next, we value defaulting to transparency because folks who are action-oriented should be equipped with a ton of context. The mission, strategy, metrics, goals, systems and processes – all of it – is well documented and organized so people can find them and take action.</p><p>We also have a feedback-oriented culture. I teach a course on feedback to all the new folks to ensure they understand how to ensure they understand how to give and receive feedback effectively because it helps us grow. </p><p>The rest of our values are outlined <a href=https://www.ycombinator.com/"https://zapier.com/jobs/culture-and-values-at-zapier/">here, but these are some of the things that drive Zapier’s culture – and as you scale, it’s crucial to create different forums to communicate these values. We have an internal tool we named Async, which is email meets Reddit. The platform is public by default, anyone can post, and information can be targeted at different groups or people. We find this is great for long-form substantive topics that have a longer shelf life (1-2 weeks) versus Slack channels (1-2 days). We also hold all hands and have a company podcast, where we capture evergreen content. For example, when we have key moments in the company history, we’ll break it down: Why we did this thing, what led to that decision, the outcomes, why it is an important moment, etc. We have found podcasts to be helpful when onboarding new folks. </p><p><strong>Why did you decide to not raise any additional funding since your seed round?</strong></p><p>The only funding we took in the history of the company was a $1.3M seed round in 2012. This was partially philosophical and partially about the business. </p><p>The three of us co-founders had worked at a fast-growing, bootstrapped company owned 50/50 by two brothers. When we came out to the Valley (we were from Missouri), we started to hear this line of thinking, “No great company has ever done X.\" Some of these statements would center around the impact of venture funding, and I was dismissive in part because I had this counterexample from my time in Missouri. So, when we raised the seed round, we decided to treat it like the last round we’d ever raise.</p><p>Our second reason for not raising multiple rounds: Across the founding team, we had all the skill sets to do every job inside the company. That meant we didn't have to hire to make progress in the early days. We even had rules in place around hiring like, “Don’t hire until it hurts.” </p><p>Then there was the third, rational component: We were able to grow quickly without external funding because of Zapier’s network effect on our developer platform side. We're able to have low customer acquisition costs (mostly through organic channels), and this is intrinsic to how Zapier works. </p><p>Along the way, some of the philosophical thinking fell by the wayside by observing other companies and realizing fundraising is a tool like anything else. There are moments when it can help you, and there are moments when it can hinder you. You should strive to understand when external funding is a good tool to use versus when it is not – and then apply it if it makes sense for you.</p>","comment_id":"62f15573ab52db0001d3b642","feature_image":"/blog/content/images/2022/08/BlogTwitter-Image-Template.jpg","featured":false,"visibility":"public","email_recipient_filter":"none","created_at":"2022-08-08T11:26:59.000-07:00","updated_at":"2022-08-15T12:08:14.000-07:00","published_at":"2022-08-09T08:55:00.000-07:00","custom_excerpt":"Today, Zapier automates work by connecting with over 5,000 apps. 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    Venture Debt 101: Basics and Approach

    by Jon Levy8/26/2021

    In this guide, YC Managing Director Jon Levy talks about venture debt. He covers what it is, walks through some of its benefits and risks, and gives advice on how to approach the process of taking on venture debt. He also highlights Brex’s newly launched venture debt offering. Brex is a YC portfolio company that provides an all-in-one finance solution to their customers. With Brex’s new offering, they have plans to make the venture debt process simple and transparent.

    What is Venture Debt?

    Venture debt is a loan to companies that have raised money from venture capital investors (“VCs”). Traditionally, banks only loan money to companies that have collateral (i.e. assets, cash flow, profits); venture debt is different in that venture debt lenders will offer debt financing to promising companies that are not cash flow positive, without existing collateral, provided that these emerging companies have raised money from VCs and show strong growth potential.

    Money is essential for companies to grow, and venture debt can be helpful. It can boost a company’s cash reserves and extend its runway. It can provide a bridge so that a founder can delay raising an equity round, grow the company and attract higher valuations. Venture debt interest rates often are based off of WSJ Prime (currently at an all-time low percentage), and venture debt may protect a founder’s ownership by allowing a founder to retain a higher percentage ownership of his/her company. While venture debt can help a founder by protecting ownership, it also carries risks and founders should understand the pros and cons before accepting venture debt.

    Venture debt investors are fundamentally different from equity investors. Equity investors understand that one successful investment can make up for a number of losses (http://www.paulgraham.com/swan.html); venture debt investors expect to get repaid on every investment. With venture debt investors, repayment is contractually required: every cent must be repaid. Venture debt investors typically tie their investment to business plan milestones, metrics like accounts receivable and revenue, or events, whereas most equity investors allow startups leeway to pivot. Unlike equity investors, venture debt investors are less flexible. These investors are not as concerned with reputational damage: while an equity investor may support a startup that “pivots” to find product market fit, a venture debt investor is less understanding, given the need to get repaid. Venture debt lenders are thus more apt to enforce a contract to make sure their money is returned, even if the company would be killed from such enforcement. These investors are myopically focused on losing as little money as possible; they rarely are interested in any other considerations.

    Strategy: How to Approach Venture Debt

    First, founders need to understand basic venture debt terminology. Founders do not need to be venture debt experts, but do need to understand their contractual obligations, particularly because venture debt lenders will rely on these contractual terms to protect their investment1. Founders need to assess which terms are important, and which ones may place their company at risk. At the bottom of this essay is a short glossary and explanation of some key terms that founders will encounter in a venture debt financing.

    Second, after understanding the basics, founders should consider evaluating multiple venture debt lenders in order to make the process competitive. Far too often, Y Combinator founders tell me that they met a venture debt lender, got a term sheet and quickly signed and agreed to terms. A founder would never speak to only one equity investor when raising a Series A round, but in my experience, it is common for founders to speak to only one venture debt investor. Fortunately, there are more lenders and new entrants offering venture debt, and founders now have additional options (more on this topic below). Working with a more friendly lender that you know well can make all the difference in a downside case, but you also should not drag on the venture debt raise process for months – you have a business to run.

    Third, founders must involve legal counsel when entering into a venture debt relationship. Again, the terms and conditions of venture debt financings arguably matter more than equity financings because lenders do not hesitate to assert their rights and will apply assertive tactics to recover every dollar they can. For example, there are important differences in the types of “defaults” that may trigger a loan to be due immediately, and experienced counsel will help protect a company and make sure that it is better positioned if things go awry. Often a startup involves counsel after a term sheet is signed, but it is better to involve counsel earlier in the process, which typically is when a company has more leverage.

    Please note that while venture debt investors need to protect their investment, they also deserve to be treated fairly. There are many instances where venture lenders have complained that companies were not forthcoming about their circumstances and did not provide relevant information such as their cash burn, or the loss of a significant lost contract. It does not help a company to hide from its lenders – the worst possible way to treat your lender is to make them think that everything is going according to plan, and then drop a bombshell on them when it’s too late to course-correct. Because there may be ways to restructure debt, it inures to a company’s benefit to treat its lenders fairly.

    Good news: New Entrant: Brex

    I mentioned there are new entrants in the venture debt space, and Y Combinator is glad that our portfolio company Brex is now offering venture debt financings to startup companies. Understanding startups’ financial needs is in Brex’s DNA: the company grew quickly because it understood the challenges startups had with accessing basic credit. Brex knows how to serve startups and young companies with a variety of credit solutions and is a welcome addition to this market. YC has shared our concerns with Brex about the pitfalls of venture debt, and Brex has plans to make its venture debt financing terms simple and transparent. While we are confident in Brex’s ability to compete in any market, we continue to believe that all startups should reach out to multiple parties when accessing venture debt. To learn more about Brex’s offering, see here.

    Conclusion:

    Venture debt clearly has many benefits — it offers startups a less dilutive way to inject capital into a healthy, growing business, a business that most traditional banks ignore today. At its best, venture debt is an effective complement to equity financing, and helps accelerate a company’s growth. But accessing venture debt is not without risks2. Founders should be realistic and ask themselves whether they are taking on a burden that can be repaid. A company is best positioned to assume venture debt when it is confident in its ability to repay the loan, which will eliminate all associated risks.

    GLOSSARY: BASIC TERMINOLOGY (for familiarity only; counsel needs to be hired):

    Commitment: What type of commitment is your venture debt investor making? How much money is being offered? When can your company access the money? Does the company need to “draw-down” over time? Can the company access all the capital at once?

    Term Loan/ Revolver: Term loans are for a set time period (i.e. 3 years) and have a fixed payment schedule. The payment schedule can be “amortized” meaning that both the principal and interest is paid through periodic payments e.g. a mortgage; a “bullet” payment means the interest payment is made throughout and the principal is paid at the end of the term (aka the “maturity” date).

    Revolvers are like credit cards or a line of credit: a borrowing limit is set by the lender. Most venture lenders charge a “commitment fee” – the fee can be a flat fee or a fixed percentage of the commitment and is intended to compensate the lender for keeping open access to the money. Make sure to understand how much money is being paid on fees: venture lenders tend to nickel and dime companies with tiny fees.

    Interest Rate: Interest rate is a crucial term and varies on a company’s ability to repay; the rate may vary from ~6-10%. Term sheets often express interest as “Prime rate plus x%”. Many lenders offer an interest only period prior to requiring repayment of principal.

    Warrants: Warrants are another critical term and provide the lender with potential upside as a stockholder in a venture backed company. Warrants are typically a percentage of the commitment (i.e. 5% of $2mm). Most lenders ask for preferred stock based on a company’s last round, but an increasing amount of recent term sheets request a set percentage of common stock. Obviously, it is important to speak to multiple lenders when negotiating interest rates and warrant coverage.

    Prepayment Penalties: Founders should make sure there are no charges for paying back their loan early (can be very useful if the market improves).

    Investor Abandonment: A clause that allows the lender to demand repayment if a company’s investor doesn’t invest in the company’s future round.

    Negative Pledge on IP: A clause that prevents a company from pledging its intellectual property to another party while the loan is outstanding. Sometimes lenders ask for a first-priority security interest on a company’s IP — this is a term companies should not accept.

    Field exams/ legal costs: Beware of hidden fees! Look for clauses that allow the lender to conduct on site exams (at the company’s expense). Make sure to cap legal fees and do not pay the lender for documents that have been drafted a hundred times.

    Current Ratio/ Quick Ratio: These financial terms measure a company’s liquidity and may impact how large a commitment a lender makes. The “current ratio” measures a company’s assets by dividing the company’s assets by the amount of liabilities. The “quick ratio” only includes the most liquid current assets that can be turned to cash quickly, and does not include inventory, supplies, etc. Venture debt lenders often use these ratios in covenants to monitor liquidity.

    Default Provisions: Defaulting on a loan allows the lender to ask for its money back and can kill a company. There are different types of defaults in venture loan contracts: technical default (violating a covenant); monetary default (missing a payment); change in status default (legal judgment); and there are subjective defaults: “material adverse change” or “investor abandonment”. It is important to maintain a good relationship with your lender, especially if there is a subjective default provision that may be triggered. In these circumstances, a lender bank may choose to revise its debt, or make the more draconian decision to send the loan to its bank’s workout group.

    1 Venture debt terms and concepts are very simple; the language may seem daunting because it is unfamiliar. The dynamic is similar to equity financings: it is disconcerting for founders when they first hear preferred stock financing terminology (e.g. liquidation preference, broad-based weighted average anti-dilution, right of first refusal and co-sale rights). But all YC founders quickly get up to speed and understand the meaning of these simple concepts. Venture debt terminology may seem unfamiliar, but also can be understood quickly.

    2 I have not listed all the risks associated with venture debt. It is important to note that unlike equity, venture debt requires a startup to agree to financial “covenants” — e.g. a startup needs approval before incurring additional indebtedness, selling assets, etc.. More important, in a downside scenario, a venture lender often influences a company’s ultimate exit. That means if a company is running out of capital and has two options, one which employees prefer and one which is better for the bank, the company probably will have to choose the option that is better for the bank. These risks further highlight why founders need to be realistic about their ability to repay. To emphasize, founders should remember that venture debt is a debt that needs to be paid back.

    Author

    • Jon Levy

      Jon is Managing Director, Partnerships at Y Combinator. He previously counseled public and private technology companies as an attorney for Wilson Sonsini Goodrich and Rosati.