Debt Is a GTM Lever, Not a Last Resort

Machine-generated transcript from the episode video. Speaker labels are not included and some names and product terms may be transcribed phonetically.

[0:00] that really aligns with how people are thinking, how people are feeling. Add on complimentary hardware to software. So I map where clarity exists and where it doesn't. Also wanting to take advantage of this massive opportunity. GTM vault where enterprise GTM actually gets built. Founders say they don't want debt, not because it's risky, but because they only see it when things are already breaking. The problem isn't that. The problem is waiting too long to use it. In this episode of GTM Vault, Michael Wallace explains why the best operators treat debt as a proactive GTM lever, not a last resort when equity or growth stalls. Welcome to GTM Vault, trusted by over 25,000 founders and operators building the future of revenue. Today's episode challenges a quiet but deeply held belief that debt is something you reach for only when options disappear. That belief is wrong. Debt fails when it is reactive. It works when it is deliberate. My guest today is Michael Wallace, CEO of Tamaya Capital. Michael

[1:08] works closely with growth stage technology companies using non-dilutive capital to extend runway smooth volatility and fund execution without giving up ownership or control. Today's core question, why does debt work best before you think you need it? Want to get right to it. Michael, why do founders usually start thinking about that only after something breaks? Thanks, Rick, and appreciate being on today to to talk about this. There there seems to be a fairly deeply held belief that success in early stage companies particularly software companies is measured by raising equity to achieve outsized exits. You see announcements of large rounds at high valuations getting the most publicity, much more publicity than a modestly successful bootstrap business having a wonderful exit to for the founder of that business. That perception that equity is the marker of success and large equity rounds are the marker of success in in early stage software businesses has a direct impact

[2:18] on founders willingness to consider alternative fundraising structures. Debt being the primary example of that seen as an alternative when the bright shiny object doesn't work the way they wanted to. What signals do you see when companies come to lenders under pressure? Sure. Our diligence. So run a midsize private lender focused exclusively on software businesses. And our diligence looks in some ways a lot like what an equity investor, a venture capital diligence process would look like. We look at many of the same metrics. We look at many of the same measurements, the same data sets that an equity investor would look at. Typically, the things that are going to cause us to to see pressure quickly, really short runways, high burn relative to the amount of cash that's sitting on the balance sheet, uh, or other forms of capital with immediately near-term expirations. So whether that's an existing piece of debt that has a short near-term expiration on it or maturity on it, whether that's a conversion feature that kicks in really quickly or some other termination or maturity associated with existing capital in the the founders capital stack. How does urgency fundamentally change

[3:29] the risk profile of an otherwise healthy business? It's a it's a great question. One is it starts to reduce options. As a founder, the less time you give yourself to source capital, the less ability you have to run a proper process to find the optimal partner. You are forced to work with people who can move quickly, who can write checks incredibly quickly. And because of that, you have less control over terms. the more urgently you are looking to source capital and put it on your balance sheet, the the fewer options you'll have and the the less optimal the economic terms of that deal will be. The the second aspect of it is not actually directly tied to the capital itself. It's tied to the decisions the founder makes when you are operating paycheck to paycheck so to speak. when you're when you're checking your bank balance every day uh to make sure that you are sequencing receivables and payables that you are lining up the cash available to make sure you don't miss payroll. You make tradeoffs in your business either overtly and directly passively even. You you know hold off on

[4:41] payables. You don't make investments that you probably should. You treat suppliers differently than you would in times of health. When does debt actually make sense as a growth lever? It's that's a another great question. It's um it's really interesting to think of in a variety of contexts. Uh debt is a great alternative for the right businesses compared to equity or other sources of capital. Equity in particular is really good at underwriting and and benefiting from high volatility outcomes, even binary outcomes. Debt is not well suited to those sorts of scenarios. Debt is particularly well suited when there is a repeatable model and a relatively certain outcome around growth around profitability around revenue. You are essentially bringing on you know specific amount of capital today and generating a very specific liability in the future. And when you have the ability to project that your business can generate more than that future liability using the capital today, that direct sort of linear tradeoff is a great use of a of debt capital versus using equity as a way to

[5:54] underwrite a much broader range of even potentially larger. What does a strong use of proceeds look like from a GTM perspective? As an underwriter, we always love to see when a founder has really solid understanding of their go-to market dynamics. They know that if they apply this amount of capital in this way, it's going to generate this kind of outcome. I know in real life it's never as easy as the formula suggests it is. There's always flex and movement and variability, but an understanding of the exact type of customer that they that the founder wants to go after, their go to market team wants to go after an understanding of how to reach that customer and the costs of doing so and how that capital can be deployed. That is an incredibly strong use of proceeds in the context of go to market. You know, when we hear that a founder wants to use debt proceeds to test, they want to try, you know, option A, option B, option C and learn to find out what's going to work. That suggests they're at an earlier stage in their go to market evolution.

[6:58] And that's where you start to think about, okay, what is the right source of capital to underwrite these high variability outcomes? Clarity, understanding as much a formulaic approach as you can get, knowing that in the real world it never is that. That's a great use of debt. The high variability testing and learning, you know, that suggests that an equity investor might be a better source of capital for for that kind of activity. Why are milestones, not optimism, the right anchor for capital decisions? We always look at a founders's history in terms of their deployment of capital. Are they principled? Are they structured? Are they frugal in their use of capital? Do they make calculated decisions and are they able to track their performance relative to those decisions? If we see a strong track record of we use this capital for this purpose, it generated this return or this yield or this result, it's gives us more confidence that that founder is going to be able to do that again with their next round of capital. If we see a more meandering path of testing and learning or not learning or you know

[8:10] mistakes in how capital was was deployed, it makes it harder for us to have a high degree of confidence that the founder is going to be able to repeat um you know what got them to the the place where we are underwriting the business. So to the extent that there's been specific milestones historically that capital's been brought on to achieve those milestones and those milestones, you know, were within reason achieved, it creates that pattern of repeatability that suggests it's going to happen again in the future. And then forward-looking, you know, it's that connection to milestones that have a degree of specificity. It shows that there's a clear point of view on how the business the founder desires the business to evolve over the course of the period in which our capital is being deployed. And that clarity of story and I expect we'll get into this farther you know in our conversation. That clarity of a vision and story and strategy is what gives a lender a high degree of confidence that their their capital will be deployed effectively.

[9:09] Why are false positives existential for lenders? The math, one of the reasons I love working in in the lending space is that the the math to me is fascinating. When we write a check to a business, the downside for us is the same as if we were writing an equity check. We can lose our money. The upside is capped. So, an equity investor can write a check into a small or mid-size company and they can ride that check all the way to a massive, you know, unicorn plus+ exit at some point in the future. And that's really what allows them to write underwrite a high variety or or variability of outcomes. For a debt investor, writing a check that goes to zero is a significant impact has a significant impact on our performance because we don't have the ability to have a 5x investment that offsets uh a right down to zero. Our cap return is essentially our interest rate. And for Tamaya in particular, we don't include warrants or options or anything else in our loans. we we just earn our interest rates. So, it's it's very important to us that we focus first and foremost on risk mitigation and find opportunities where we are protected from the downside when we're deploying capital. But we

[10:20] have to based on the math of of how debt investing works. And how do you distinguish structural risk from transitional risk? That's always a a tough question when we look at a business, you know, particularly a business that's going through a period of transition, a pivot perhaps, or they're in a highly volatile market. Um, we look at a business like that differently than we would a business that has been doing some of something and wants to do more of that same thing. Uh, it's always easier to underwrite a business that has been really good at one thing and they want to do it twice as opposed to once, right? or they want to do it 10 times as opposed to five times. That linear progression is much easier to get your brain wrapped around. It's much easier to underwrite. It's much easier to link that with the ability to repay a loan at some point in the future when the growth story for a company involves, you know, we've done a little bit of A and now we're going to do a whole lot of B and maybe even some C. That becomes more complicated to underwrite. Now we are underwriting, you

[11:27] know, something that we don't have data for. Frankly, we're underwriting the business's and the management team and the founding team's capability to do something new and unique. And again, not to to sort of go back to that same concept, but that in many cases, you know, is an argument for equity capital where that volatility or variability and outcome is and the upside that can come from it is is perhaps better suited for those variable scenarios. the from an underwriting perspective our challenge is to identify scenarios where there is less volatility and outcome where there is more you know less transitional risk if you will where do strong operators get misread by traditional or underwriting models. It's exactly the the situation that we just talked about, which is periods of time where the business is going to be doing something different in the near future than it has been doing historically. An equity investor in particular, but often debt investors as well, can place a high degree of confidence on an outcome if they have a high belief in that operator. That's where you need when you

[12:39] are underwriting something that is much more, you know, much newer, much more unique, much different than what a business has been doing historically. You have to place more weight on the operator and their ability to to achieve that. And in general, debt underwriting models in particular rely on data, right? And that's a scenario where there isn't data because they're going to be doing something different and unique. That's that's a challenge for debt underwriting models where we need to look at what exists now and there's a little bit of projection or a little bit of estimation about what will come in the future. That's a situation where it's tough to incorporate into our underwriting the unique capabilities of a top tier operator. And what would you say are the most common red flags across other otherwise solid companies? Red flags to us will probably come as no surprise. I think the the biggest red flag that is at a fairly strategic level is do we see a logical and consistent strategy that's been laid out for the business? Is the strategy that's articulated to us as a lender connect to

[13:45] what the business has historically been good at? Does it connect to the metrics that we're seeing, the financial and operating metrics of the business? And does it connect to the capabilities of the team? So that's the top level. If there isn't a degree of logical consistency in that strategy, it's hard for us to understand how our capital can help them achieve that. You know, much more mechanically, we then take a step down and say, you know, what are the things that individually would cause us a lot of heartburn as we are underwriting a transaction? And none of these will be surprises. Do we see an incredibly high level of cash burn relative to the resources on hand? Do we see troubling go to market metrics? Really high cost of customer acquisition, really high churn, things that indicate that the machine isn't functioning the way it is supposed to. You know, do we see unique or undesirable margin dynamics relative to the industry? any one of these sort of financial or operating metrics individually really low growth can give us a sense that there's something worth digging into a little bit. Ultimately the decision to invest is taken by

[14:57] looking across all of them as a whole. So none of them independently would be a a dealiller but each one of them could be a red flag that suggests there's something working underneath that we need to spend some more time on. Why do financial hygiene issues kill deals faster than weak growth? The companies that Tamaya lends to typically generate between two and 10 or 15 million in revenue. So these are established companies, but they're not enterprise companies. They are still very much startups. The majority, if not all of them, are still founder. Many of them are bootstrapped and wouldn't have had an institutional investor on their cap table. Safe to say we are used to seeing a whole host of a whole variety of quality of financial statements um from cashbased spreadsheets all the way up to institutional quality acralbased uh audited financial statements. We talked earlier about the idea that we want to see a consistent strategy that's has an internal logic to it and says we have you know connects the future of where the company is going to the result

[16:06] the company has achieved historically. It's very difficult for us to underwrite the effectiveness of that strategy and the consistency of that strategic story if we can't feel confident in knowing how the company has evolved to where they are today. If they can't clearly articulate their gotom market performance based on the cost of customer acquisition. if they can't clearly articulate to us what their churn metrics are because they're pulling data from multiple different systems or you know in one system the company name the customer names don't match what they are in the other system. So you do a bunch of manual work to connect those if there are consistently changes in their profit because their cost acrruals you know move monthtomonth without a degree of logic behind them.

[16:57] All of those, you know, independently or taken together make it challenging for us to know what's actually happening. And if we don't have a degree of confidence in what's actually happening, we can't develop a degree of confidence that the strategic story that connects what the business has done historically and what they're going to do in the future. We can't evaluate whether that's reasonable and we can't build confidence in in whether that's reasonable. That's ultimately why we we need the metrics and the underlying data to be to be fairly rock solid. Yeah. And I imagine that's why with no data, messy numbers undermine trust before the real story is even heard. Does that happen in most cases? It definitely can. Yeah, it's um when we ask what seem to be relatively straightforward diligence questions and it takes an extended amount of time and multiple people and multiple systems and lots of back and forth and we find inconsistencies. It is hard for us to then go to our investment committee and say the metrics we use for underwriting are true and accurate and we believe

[18:03] them. And it's in many cases frustrating because we'll you for the founder and for for us obviously we'll we'll see great businesses with great founders who are pulling their hair out because the lack of investment they've made in their financial systems over an extended period of time has compounded and is now impacting other parts of their business. In many cases, have you made the right acrruel adjustment? Have you booked uh you know R&D capitalized R&D in the right way for an extended period of time? have you, you know, are there any offbalance sheet liabilities that you haven't tracked properly? Like these are little things that, you know, 10 grand here, 50 grand there, you you don't think about too much at the time. Um, and you know, at the end of the month, there's always cash in the bank, so things are fine. But then when you try to put together that financial picture, it can be incredibly frustrating to to do the work to get your financials to the right right place. it, you know, very similar, I would imagine, I'm not an engineer, very similar to dealing with tech debt, right? You can have financial statement debt, if you will, of of work that should have been done, you know, over a long period of time,

[19:10] and it it catches up to you when it comes time to sit down with a lender. What signals tell lenders a company is truly in control? The signals that we look for, again, first and foremost, clarity of strategic story. So what we've done historically has taught us X and got us to our current position. We are making investments in these places and that's going to drive this outcome. If that is a logically consistent story, that's the first starting point. And in particular, why our capital or anyone's capital is contributing to that story is important as well. Right? We need capital because we ran out of money is is not an effective, you know, portion of that strategy. We need capital to unlock these three strategic opportunities and we're going to deploy it uh to make these four investments and realize these outcomes is a clear strategic story.

[20:01] That overarching message is the first and most important piece that gives trust to a potential investor. below that. Knowing your numbers, which which seems straightforward, but knowing your numbers and not being surprised by the questions that we ask through diligence is is the the next biggest piece. It it shows us that you as a team have your finger on the pulse or your thumb on the pulse of what's going on in your own business. You know where to go to get answers. It's helpful in terms of letting us get a full picture of your business, but it also shows that if something were to happen in day-to-day operations, you'd similarly know where to go to fix it. So, that ability to answer questions about your own business quickly uh and and clearly is a big uh a big thing that gives us confidence.

[20:48] How does predictability change the relationship between founders and capital providers? Predictability is is never perfect, but predictability ultimately limits or reduces the var variability in outcome. Any investor, debt, equity, otherwise would love it if there was no variability in outcome. You underwrite a forecast and every year you come within a certain percent certain number of percentage points of that forecast is an absolute ideal scenario because it suggests that what you told investors you were going to do you went and did. That's never going to happen in in real life. There's always a significant amount of variability whether it's in the numbers, whether it's in the team, whether it's in the the market, there will always be variability. To the extent that you can as a founder and as a business, limit the variability and therefore improve your predictability on the things that you can control, it gives confidence to investors that a good chunk of what they underwrote is going to work the way it's supposed to. There will always be things out of your control as a founder and as a founding team. Investors regardless of debt or equity,

[21:59] you know, have to incorporate that in their underwriting to a certain extent. Control the things you can control. Ideally, generate outcomes, you know, that connect to what you said you would do. The the higher the ratio between the achieved outcomes and the promised outcomes, the uh the better you are. And the higher that predictability, the more capital partners you will have available to you as a founder to work with. What should founders be thinking about long before they need capital? The single most important thing I think is connecting the type of capital that you are seeking with the application of that capital in your business strategy. for a long time. And this connects back to the general sort of point of view that success in in software and early stage technology businesses is measured by massive outcomes and significant equity rounds to help get you there. Most businesses are not suited to be venture-backed businesses. Even most software businesses arguably are not suited to be venture-backed businesses.

[23:04] the the math of of sort of straight down the middle venture capital investing requires outrageously large outcomes. And if your business is not suited for that, then you're better off looking for different alternatives. And increasingly in the capital and the fundraising market, there are other alternatives to venture capital where maybe 10 or 15 years ago there weren't. The fact that we exist is is one of those, right? As a as a software focused, growth focused lender. So as a founder as you're thinking you know 6 months a year two years whatever it is ahead of needing a type of capital think about how your business strategy the potential outcomes connects to the requirements of the investor's business model you know as a debt investor I don't need you know a moonshot outcome all I need is consistent growth in excess of the interest rate that I charge as a venture capital investor, you're looking for something very different, right? You know, I don't need a triple triple double double, right? I need consistent regular growth. If you have a business

[24:10] that is better suited to generate consistent regular growth, think about the right source of capital. Think about planning your business and planning your fund raise to match the type of capital that's best suited for your business. I think that would be the the first thing to think about well in advance of actually phoning up some investors and pitching your business is that strategic connection. Yeah. Because at the end of the day, if you want to um always have control over your board, the minute you start take I mean earlier stages, sure you start taking some outside capital, eventually you're going you start on a path where you lose control of of the company. So that is a big tradeoff. that people need to think about. Absolutely. We we work with both equity funded businesses and bootstrap businesses. We work with a variety of folks somewhere in the middle of that spectrum. Different businesses are better suited for different capital structures and the connection between your capital structure and the potential for your business and the strategy for your business is incredibly important.

[25:16] There there is an investor out there for every type of outcome. Your trick as a founder is finding the investor that is best suited and best aligned to match the outcome that you're looking for in your business. How early should teams build relationships with lenders? Building a relationship with any investor is is always a trade-off between the amount of effort it takes to grow and maintain that relationship and the amount of the immediacy and need for that relationship to bear fruit. If you are planning to raise equity or debt 5 years from now, investing upwards of half your time building relationships with capital providers is probably not the right answer. Ultimately, as you build your fundraising strategy for your business, and assuming that aligns with your overall business strategy, that's the point in time to start saying, who are I've figured out the type of capital that I would like for my business. Who are the exact right investors that best align with this source of capital? when am I going to need them to write me a check and let's work backwards so that my first interaction with them is not

[26:24] can I please have a check this week it is let's you know whether that's three months whether that's six months whether that's a year or two years you know it's probably not two years but think through the process and the amount of time it's going to take you to get to know these investors to learn more about their business and to slowly share more about yours so that when it comes time to start an actual underwriting process, which typically takes a few months, you're not meeting them for the first time. You know, in in those cases, you are much more likely to be successful. If you think about that in any other business context, you'll you'll come to largely the same answer. If you're thinking about courting a customer, you know, it's it's often you spend time getting to know them before you make a hard sales pitch. If you're thinking about recruiting um a senior executive, you spend time getting to know that person before you put an offer across the desk to hire them. Anything that is of strategic importance to your business, you spend the requisite amount of timeline to build a relationship in advance before completing a transaction. And I think capital can be can be managed in in largely the same way.

[27:32] Why does optionality disappear faster than founders expect? there there's a whole variety of things. So through that period of time where you're building relationships with potential investors, there's a whole variety of things that can impact your optionality. There's the amount of cash you have relative to the amount of cash you're spending. There's which impacts the urgency of of way you need capital. There are shifts in the market where competitors of yours may be raising capital at the same time. There's shifts in the interest rate environment which could impact the availability of LP capital for either investors, equity or or debt investors. All of those things change the urgency or the need of your capital for you as a founder and therefore start to reduce optionality. As soon as you start down the path with an individual investor, you know, depending on the scenario, you may start to limit the ability to talk to other investors. Um and in particular once you take money from somebody that's the biggest time when your optionality starts to become severely limited. If you raise capital equity capital you

[28:41] generally will set a valuation for your business or you'll agree to a set of terms depending on the structure around that equity investment that will have a direct impact the next time you want to raise capital. If you put debt onto your balance sheet, the existence of that debt and the security that that lender has on your business limits your ability to then do that again in the future. There's now a set of terms and conditions that you have to work within. Any of those things have an impact on your ability to raise additional capital in the future. You should always go into any capital relationship eyes wide open about the exit from that capital relationship and uh and what limitations it places on you. Why is cap downside often more powerful than uncapped upside? Equity and debt investors have a very different dynamic in their math. We talked about this a little bit earlier. Very similar downsides in both cases. You can write off an investment to zero.

[29:41] Debt investors have a capped upside, equity investors have an uncapped upside. That dynamic and the impact that dynamic has on portfolio construction and the types of investments folks are willing to make uh on the investor side directly impacts what someone's willing to underwrite. And the willingness to underwrite certain situations has a direct impact on the type of companies that those investors look for. Equity investors look for a much wider variety of companies. Debt investors love having companies fit entirely into a box. Um the both of those folks have a very similar cap downside. Equity investors are much more worried about the upside, [clears throat] much less worried about the downside in their strategies in most cases. Not all, but most cases. Um and debt investors react very differently. I think the the biggest it's somewhat of a complex topic. The biggest thing to think about as a founder is what logic and strategy goes into the investment decision that your partner is making. How is your partner thinking about

[30:50] upside and downside and what does that mean for their willingness to provide capital in general or capital on specific terms? And understanding that connection will allow you to think about how that investor will fit into your strategy and in into your business. How should founders think about capital as part of the GTM operating system? When we're underwriting a business, we love to see a go to market motion that operates like a machine. You know, in an ideal world, it is very specific inputs, a very specific process, and very predictable outcomes. It's never like that in per in in it's never like that in in practice. Uh but we would love to see something like that. And when that's the case, the application of capital is very easy. We know that an investment here will generate this activity and will generate that outcome which will allow our initial investment to yield a expected return. The more machine-like, the more clarity there is, the the more a founder can trust capital to be a key cog in their go to market machine. The

[32:01] less structured, the less organized, the less certain their go-to market machine is, the fewer capital options are available to to fund that machine. Uh, and as I mentioned earlier, you're looking for capital that can underwrite a wider variety of outcomes. So the the connection of your go to market machine to your capital source is is different when you're still developing that go to market motion. Something to think about for for founders as they select which type of capital is best suited to be the input into their go to market motion. I'd like to move on to the rapid fire section of the pod. In one sentence, first instinct, what is the biggest misconception founders have about debt? That you only get it when equity doesn't work. Debt can be a strategic tool just as much as equity or any other source of capital can be. It's all about alignment and connection to your strategy. What is the first financial signal lenders look at?

[32:58] Single most important financial signal we look at is financial health. How much capital is available for the business and how long will that capital last? What makes a company financable even before scale? clarity of strategy and consistency of execution. What mistake do founders at 3 mil to 10 mil arr keep repeating? Scaling infrastructure, people in particular without a clear point of view on the return that those investments make and without the willingness or ability to respond quickly if that return isn't generated. Wood belief about debt is simply wrong. That's that's not necessarily a bad thing. A business with debt on the books is not a distressed business. Debt can be a very useful tool particularly for founders that are sensitive about dilution and want to maintain control.

[33:50] It should be used carefully, but it is a a very powerful tool. It's it's not a signal of distress. Founders think about capital when pressure forces the decision. Operators design leverage before urgency arrives. That is not a rescue tool. It is a control mechanism. When paired with discipline, clarity, and execution, capital becomes part of the GTM system, not a reaction to its failure. Michael, thanks for bringing operator level clarity to one of the most misunderstood levers in growth. This is GTM Vault. Build systems, not noise. The GTM operating system for teams building repeatable revenue.