Foursquare resorts to debt in latest financing

Foursquare, a service that helps smartphone users find nearby restaurants, shopping venues, clubs and tourist attractions, said on Thursday it raised $41 million in a new financing round that relied on debt, rather than equity, to give the start-up the money it needs to keep expanding.

The cash came from a new investment by technology private-equity firm Silver Lake, through its Waterman growth debt fund, as well as existing investors Andreessen Horowitz, O'Reilly AlphaTech Ventures, Spark Capital, and Union Square Ventures, Foursquare founder Dennis Crowley wrote in a blog.

The Silver Lake money is a loan that has to be repaid over several years. Existing investors bought the convertible debt, according to Fred Wilson, principal of Union Square.

Debt financing is unusual for start-ups, which typically rely on selling equity to early investors. Resorting to debt is typically considered a sign of stress in the venture capital community. It mounts pressure on young companies, which may not have a lot of revenue or earnings to repay such obligations.

LivingSocial, a struggling daily deal start-up that competes with Groupon Inc, had to issue new equity with debt-like aspects, such as an annual dividend, in its latest financing round earlier this year.

"I haven't seen anything this bad in a while, and certainly not something so high profile," said Rocky Agrawal, a Silicon Valley-based analyst who focuses on mobile technology and payments. "It's not very far from this LivingSocial-just structured differently."

Foursquare launched to much fanfare in 2009, but has since struggled to generate revenue from its business. The company is now focusing more on its search capabilities, which allow users to track down stores and other physical locations through smartphone apps.

Foursquare has just started building revenue-generating businesses such as services that help local businesses find new customers and market to them. This will be "much more developed" in the next year, Wilson said.

Foursquare generated $2 million in 2012 revenue, according to Bloomberg Businessweek, which reported the Foursquare financing earlier on Thursday.

Crowley declined to comment on Foursquare's revenue, however he said that the company did not begin to focus on revenue generation until last year.

Crowley also said that investors "had a hard time" valuing Foursquare because the company is changing so quickly.

In June 2011, Foursquare raised $50 million at a $600 million valuation from Andreessen Horowitz, Union Square, Spark Capital, O'Reilly AlphaTech and CrunchFund.

The latest $41 million financing was structured to avoid investors having to come up with a valuation for Foursquare right now, according to Crowley and others.

Foursquare will have to pay interest on the new debt it issued to Silver Lake. Interest is also typically paid on convertible debt. Later on, this type of security can convert to equity in certain agreed-upon circumstances, potentially diluting existing shareholders' investments.

"My general take on convertible debt is that it's 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," Union Square's Wilson wrote in a blog on Thursday.

For Foursquare, convertible debt is the "optimal solution for everyone," Wilson added.

"This round is not dilutive to the Foursquare management at this time," Wilson said. "But it will be dilutive when the debt converts into equity, most likely at the next equity issuance."

If the strategy works out, and revenue increases, that will make the company easier to value. At that point, it could issue new equity and the convertible debt would be exchanged for new stock.

"We get the comfort of knowing that eventually our investment will become equity," Wilson said. "In situations where a valuation inflection point is on the horizon, convertible debt can be an excellent structure."