Fred Wilson Explains Why Foursquare Just Took On So Much Debt

Foursquare just raised $41 million in debt. Most of it is a loan from Silver Lake, a private equity firm. But some of the money is something called "convertible debt," raised from existing Foursquare investors Andreessen Horowitz, Union Square Ventures, and Spark Capital.

In the following post, Union Square Ventures partner Fred Wilson explains the logic behind the deal.

Reading between the lines, it sounds like if Foursquare had had sold equity, its valuation would have been lousy – or at least down from a previous valuation of $600 million. The debt deal increases risk/reward for common shareholders, including employees. It increases risk in that if Foursquare can't find a home run, they walk away with nothing. But since debt isn't dilutatitve, it also also increases reward if they can hit that home run. Here is Fred's post:

I've written about convertible debt a few times on this blog, most notably here and here. My general take on convertible debt is that its very good for the founders and not very good for the investors in seed and early stage investments and a much better solution in late stage financings, which I mention at the end of the second linked post.

We have a good case study on late stage convertible debt today and I thought we should not miss an opportunity to talk about it. My partner Albert blogged about the $41mm Foursquare financing on the USV blog today. You will note that the investors bought convertible debt. And this is a classic situation where convertible debt was the optimal solution for everyone.

In the Foursquare situation, the convertible debt was purchased by a group of insiders led by USV and Andreeesen Horowitz. Both of our firms have been investors in Foursquare for several rounds and both of us own a meaningful stake in the company. Valuation is somewhat immaterial to us as our stake in the company is not going to increase much in this round of financing. But valuation is very material to the Foursquare management team because $41mm of capital is going to be dilutive at any valuation that would make sense here.

So the optimal structure is convertible debt. That means this round is not dilutive to the Foursquare management at this time. But it will be dilutive when the debt converts into equity, most likely at the next equity issuance. For the investors, we get the comfort of knowing that eventually our investment will become equity and we will not have to price it. Someone else will.

In Foursquare's specific situation, it makes even more sense because the company has just released an entirely new iOS version which gets iOS to parity with Android and completes the transition toward social search and curation which we all believe better positions the company in the minds of consumers. Also, the revenue model is in its early stages and will be much more developed in the next year. In situations where a valuation inflection point is on the horizon, convertible debt can be an excellent structure for everyone involved. And that is very much the case here.