Traunch Splitting Payments for Investor Risk Management

Traunch Splitting Payments for Investor Risk Management

Traunch: Splitting Payments for Investor Risk Management

What Is a Traunch?

A traunch is a series of payments over a specified period, subject to achieving certain performance metrics. It is commonly used in venture capital (VC) to fund startup companies.

The term "traunch" comes from the French word "tranche," meaning "slice." It is also used in securitization, such as with mortgage-backed securities (MBS).

Key Takeaways

  • A traunch is one of several investments subject to meeting performance targets.
  • It reduces investors’ risk in VC investing.
  • Traunched investments can make it challenging for entrepreneurs to grow their business due to reduced flexibility and limited time.

Understanding Traunches

Investors mitigate risks by dividing their capital contributions into separate traunches. For example, a startup may receive $5 million in financing split into two traunches—$2.5 million today and the remaining $2.5 million paid later upon achieving performance milestones.

Dividing the investment helps investors by allowing them to withhold funding until the company demonstrates progress. The company must meet targets for product development, revenue, fundraising, or other goals within each traunch’s timeframe, which can be challenging for early-stage startups.

Difficulty for Startups

This reduced flexibility can make it challenging for startups in various ways. Limited capital affects hiring and retaining personnel. Additionally, the traunch structure creates misaligned incentives between investors and entrepreneurs. Entrepreneurs may avoid communicating problems that could cause the next traunch to go unpaid or manipulate performance figures to mislead investors.

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Moreover, traunches make it difficult to adapt business models to new opportunities and unforeseen risks, as the chosen performance goals may become irrelevant. Entrepreneurs are forced to prioritize less important milestones over more significant opportunities.

Real-World Example of a Traunch

Suppose you are the founder of a startup that agreed to a traunched investment. Under the terms, you will receive $1 million today, $2 million in 12 months, and another $7 million in 24 months.

To secure the later rounds of funding, you must hire for various positions within 12 months and generate at least $500,000 in revenue within 24 months. Failure to meet these targets means forfeiting the next traunch of funding.

You have concerns about meeting these goals. Hiring may be challenging without guaranteeing roles for more than 12 months. Attracting customers and partnership agreements necessary for revenue growth may also be difficult.

Moreover, potential customers and partners may delay agreements until your company achieves a more secure financial footing, further hindering the revenue goal.

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