Monthly Archives: September 2014

Paying for the Past

credit cardsMany companies asking for investment have incurred debt in advance of receiving angel or venture funding.  Standard business debt (e.g. equipment financing or short-term payables) typically is not an issue for investors.  However, when the debt is money borrowed in lieu of (or lacking access to) investment capital, and the lender expects to be repaid, this can create difficulty in obtaining new investment capital.

I have seen entrepreneurs fund the initial stages of their companies through credit cards, home equity loans (their own or a family member’s), unsecured loans based on personal credit, and funds borrowed short term from friends.  These entrepreneurs often need to pay back the debt as soon as the financing round closes.  I’ve also seen companies in its early stages “borrow” money from employees by paying them in IOUs rather than cash, accruing the amounts owed on the books with an expectation that these amounts will be paid once the financing is in place.  This can create a legally-binding contract for payment to these early employees.

As a general rule, new investors do not want to see cash go out the door to pay for the past.  Investors are already sensitive as to how much of the financing round will go to pay the costs of the fundraising (typically legal fees, which can run from $10,000 to $100,000 depending on the amount raised, complexity of the transaction, involvement of multiple law firms and identity of those firms).  The last thing they want is to see hundreds of thousands of dollars (or more) being used to pay down debt, accrued salaries and other obligations.  Depending on the level of debt, this alone can dissuade a new investor from participating.

Entrepreneurs need to be creative in the early stages of building a company, cobbling together whatever sources of funds they can to create the next Google, Facebook or Linked-In.  While cobbling, the entrepreneurs need to be aware that the promises they make to people in the early stages can impact their ability to raise subsequent necessary funds.