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I am a co-founder of a tech startup which launched earlier this year, we have a live website and iOS app and are in the process of seeking investment to take the project to the next stage and start to generate serious revenue.

Our current valuation is £1million. However, we have been offered £2million by an investment group. This would not be offered as traditional equity. Instead they are requiring both equity and debt. They want 25.1% equity, and the loan is due to be paid back with 6% interest. Debt payback would begin 2 years after we sign the contract.

I am unfamiliar with debt investment, is is common idea? Does this sound like a good idea for us? I would hope that after 2 years we were generating enough profit that we could pay £10,000 back per month without breaking a sweat. The £2million would really give us the ability to break into our market and move forward quickly. Are debt investments good for young startups? Are there any problems which may occur with this style of investment?

EDIT: The creditor does not want veto power or voting shares, and the debt is signed to the company not to any individual founders. There are some alternative investors, but not at this amount, instead they are at the 150-300k amount. We have no revenues at present, and our cash zero date is around the corner. In 2 years, when we have to pay back the loan, we should be gaining about 46k per month profit.

closed as off-topic by ChrisInEdmonton, JoeTaxpayer Oct 12 '14 at 17:27

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    I think this question appears to be off-topic because it is not about personal finance. – ChrisInEdmonton Oct 12 '14 at 16:44
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Please confirm: Are they asking for the entire sum to be paid back in full AND for 25% ownership? If so, I think that means they're getting 25% for, essentially, the cost of the interest they aren't charging on that loan.

Run the numbers and figure out how much that actually is, and then think about how much you need this infusion of cash right now (whether you'd take out a loan at this effective interest rate) and whether someone else is likely to make you a better offer for that amount of ownership.

  • I've updated the question because it didn't explain the sitituation properly. The actual deal is They want 25.1% equity and the loan is due to be paid back with 6% interest. Not 6% per month, the loans can be paid over a more flexible schedule – Mantry Oct 11 '14 at 15:59
  • OK, that's still something you can run the numbers on. They're getting a share of the company AND a direct return on their investment in the form of interest. Think about what the interest will cost you over the life of the loan, consider whether you can get investment/loan from other sources (perhaps separately) for less total cost, make appropriate decision. I can't tell you whether this makes sense or not; you have to evaluate it in terms of your own needs and options. – keshlam Oct 11 '14 at 17:23
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Think about this as 2 separate offers. If you're valued at £1 million, that 25% equity is worth £250,000. Pulling this out, you are left with a £1.75 million loan. If you consider your loan payments as being on this amount, your interest rate is about 6.86%. Base your decision on this.

I don't know how common this sort of investment is for a startup, but you are basically describing selling a private placement bond. Selling bonds is very common, and considering your size this sort of private placement seems appropriate. With these sorts of debt issuances, there are generally covenants that will cover what happens if you miss a payment, best case scenario is they ruin any chances of further fund raising. Worst is they force a liquidation of your company.

The upside is that you will retain more of an equity stake in your company. So if you take off you will be giving your investor less of your profits.

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