What Is a Traunch?
A traunch is the series of installments that are to be distributed within a specific time frame with certain performance indicators being met. It is often employed by the venture capital (VC) circles to describe the funding rounds that are used to help fund start-up companies.
“Traunch,” as a word “traunch” is derived from the French word “tranche,” meaning “slice.” The term”tranche” is utilized in the context of securitization, such as Mortgage-backed Securities (MBS).
Understanding Traunches
One way that investors try to minimize the risk of investing in startups is to divide their capital investment into different transactions. For instance, a start-up company may want to get $5 million of funding. Instead of paying the whole amount at once, the financier could offer a deal that the $5 million will be split in two traunches–$2.5 million right now and the other $2.5 million will be paid in the future subject to certain performance goals being achieved.
From an investor’s point of view the investor’s perspective, splitting an investment into traunches reduces risk as it permits investors to defer some of the funding planned unless the company shows progress towards the business strategy. These could include targets for performance for the development of products and revenue goals, as well as additional fundraising, or any other objectives. In general, businesses have limited time to reach the goals set in each report, which is a problem that arises from the beginning of the startup process.
Difficulty for Startups
Naturally, this decreased flexibility could make life difficult for a startup in many ways. In the case of hiring, only a portion of the capital investment could make it difficult for the company to get the people it requires to effectively develop its offerings. In addition, even if candidates are employed, the absence of an adequate funding source can make it difficult to keep the individuals.
Investments in traunch can also result in an imbalance of incentives between both the investor and the entrepreneur. From the perspective of the business owner, it could be tempting to not communicate with investors about the issues that the company faces, especially in the event that those issues may result in the next traunch not being paid. The traunch arrangement can encourage entrepreneurs to manipulate their performance numbers and confuse investors into thinking they are progressing towards their goals.
Additionally, they may cause difficulties for entrepreneurs to adjust their business model to take advantage of new opportunities and to avoid unanticipated risks. There is no assurance that the objectives set at the beginning of the investment will be relevant in the years to come. In this regard, the traunch structure could make entrepreneurs choose to prioritize insignificant milestones, whereas more significant opportunities could arise.
Real-World Example of a Traunch
If you’re one of the owners of the start-up business that has recently signed an unconfirmed investment. According to the conditions of the financing agreement the company will receive $1 million in the present as well as $2 million over the next twelve months and $7 million over 24 months.
In order to secure these additional rounds of funding, you need to achieve certain objectives. In the coming 12 months, you will need to recruit for a variety of jobs. In the next the end of 24 months you need to earn at least $500,000 in revenues. In the event that you do not meet these requirements, it means that you’ll lose the next tranche of funds.
Although you have agreed to these conditions, you’re worried about the fact that you might be unable to comply with these requirements. It is possible that the person you’re looking to recruit is hesitant to join your company due to the fact that you are unable to ensure their employment for longer than 12 months from the beginning. In addition, you expect that it will be difficult to get the customers you want and partner agreements that you need to reach your revenue goals.
If your business’s long-term prospects are uncertain prospective customers and partners may want to hold off the signing of agreements with your business until it is in a more stable financial position. This could make it more difficult to reach your revenue target.
