Traunch: Splitting Payments for Investor Risk Management

What Is a Traunch?

A traunch is one of a series of payments to be paid out over a specified period, subject to certain performance metrics being achieved. It is commonly used in venture capital (VC) circles to refer to the fundraising rounds used to fund startup companies.

The term "traunch" is based on the French word "tranche," meaning "slice." The term tranche is also used in the context of securitization, as with mortgage-backed securities (MBS).

Understanding Traunches

One of the ways that investors seek to mitigate the risks of investing in startup companies is by parceling their capital contributions into separate traunches. For example, a startup company might wish to receive $5 million in financing. Rather than rendering the full amount upfront, the investor might offer a deal in which the $5 million is split into two traunches—$2.5 million today and the remaining $2.5 million paid at a future date, subject to certain performance milestones being achieved.

From the investor's perspective, dividing an investment into traunches helps reduce risk by allowing the investor to withhold some of the planned funding unless the company demonstrates progress in its business plan. This can include performance targets relating to product development, revenue targets, additional fundraising, or other such goals. Typically, companies have little time in which to achieve the targets set out in each traunch, which is a challenge incurred by the early startup process.

Difficulty for Startups

Of course, this reduced flexibility can make things difficult for the startup company in a variety of ways. When hiring, obtaining only a limited amount of the invested capital can make it difficult for the company to attract the personnel it needs to efficiently develop its offering. Moreover, even when candidates are hired, the lack of clear funding can make it difficult to retain those candidates.

Traunch investments can also produce a misalignment of incentives between the investor and the entrepreneur. From the entrepreneur's perspective, it may be tempting to avoid communicating with the investor about problems facing the business—especially when those problems might cause the next traunch to go unpaid. Similarly, the traunch structure can incentivize entrepreneurs to manipulate their performance figures and otherwise mislead investors into believing they are making steady progress toward their mandated goals.

More broadly, they can make it difficult for the entrepreneur to adapt their business model to meet new opportunities and avoid unforeseen risks. After all, there is no guarantee that the performance goals chosen at the onset of the investment will remain relevant over the following years. In this sense, the traunch structure can compel entrepreneurs to prioritize relatively unimportant milestones when other, more important opportunities might present themselves.

Real-World Example of a Traunch

Suppose you are the founder of a startup company that recently agreed to a traunched investment. Under the terms of the financing agreement, your company will receive $1 million today, $2 million in 12 months, and an additional $7 million in 24 months.

To secure these later rounds of funding, you must meet certain goals. Within the next 12 months, you must hire for a range of positions. By 24 months, you must generate at least $500,000 in revenue. Failure to meet these targets means you will forfeit the next traunch of funding.

Though you agree to these terms, you are concerned that you may struggle to meet them. You wonder if the staff you need to hire will be dissuaded from joining the company considering that you will be unable to guarantee their role for more than 12 months at the start. Similarly, you anticipate that it will be challenging to attract the customers and partnership agreements necessary to achieve your revenue goal. 

Given that your company's long-term prospects are in question, potential customers and partners might wish to delay signing agreements with your company until it achieves a more secure financial footing. This, in turn, could make it difficult for you to achieve your revenue goal.