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Foursquare announced on Thursday that it has raised $41 million in financing from a group of venture funds, but in an interesting twist the funding is convertible debt rather than equity. To some, that reinforces just how much pressure the company is under to show that it has an actual business, and that it can someday generate enough value to justify the financing it has already raised. In other words, the company and its investors have upped the ante on an ambitious bet.

BusinessWeek broke the news of the Series D funding round early on Thursday, an article that was quickly followed by a post from founder Dennis Crowley on the official Foursquare blog — entitled “Continuing Foursquare’s Growth” — and posts from two separate partners at one of the company’s main financial backers, New York-based Union Square Ventures.

Crowley compares the challenges to Google

In his post, Foursquare founder and CEO Crowley describes the challenges ahead — including some fairly dramatic technical challenges, such as the need to index and filter more than 3.5 billion check-ins and other location data in something approaching real time, in order to successfully recommend to users a restaurant or other business that fits their needs. Crowley compares it to the kind of data wrangling that Google has to do in order to provide search results:

“To us, this is like when Google came and revolutionized web search. Suddenly, you could find things on the internet. The real world is the same way. Four years ago when we started Foursquare, it was really hard to discover a new retro arcade that opened up on a side street, or to make sure you weren’t overlooking the best dish on the menu, or to know a good friend was just around the corner. Sometimes, we think of Foursquare as having the ability to give people superpowers for exploring the real world.”

In a post at the Union Square Ventures blog, Albert Wenger talked about the potential for Foursquare to capitalize on its new focus as a platform for discovering local businesses — something GigaOM’s Eliza Kern highlighted in her post on the newly redesigned Foursquare app, which launched on Wednesday. In effect, the company is going head-to-head with local recommendation services like Yelp, and giving up its earlier focus on “gamification” elements like mayorships and badges.

Debt instead of a lower valuation

Union Square Ventures partner Fred Wilson, meanwhile, wrote a post on his own blog about the fact that Foursquare chose to (or was forced to) use convertible debt rather than equity. As Wilson explains, this kind of late-stage debt issue is often used when a company doesn’t want to (or can’t) raise equity because doing so would involve a “down round” — in other words, raising money at a lower valuation than it was given in earlier rounds. As he described it:

“Both of our firms have been investors in Foursquare for several rounds and both of us own a meaningful stake in the company. Valuation is somewhat immaterial to us as our stake in the company is not going to increase much in this round of financing. But valuation is very material to the Foursquare management team because $41mm of capital is going to be dilutive at any valuation that would make sense here.”

As Foursquare has evolved from being a fresh young startup with the hot iPhone app — which it was in 2009, when it launched at the SxSW festival — into a four-year-old company that has raised a total of $70 million in three separate rounds, it has faced increasing pressure to prove that it has a real business, along with questions about whether it can ever justify its earlier valuation, which was in the $600 million range. In a report in January, private-company research firm PrivCo argued that Foursquare could go out of business by the end of the year unless it raised more money.

In a much-publicized spat on Twitter last month, investor Keith Rabois — a former PayPal founder who is a backer of Foursquare competitor Yelp — said Foursquare’s only option was to be acquired, because it had failed to back up its valuation with any real business success.

@dens @sriramk @hunterwalk great use of jargon. Maybe Hail Mary Bebo-style acquisition will bail you out. — Keith Rabois (@rabois) March 16, 2013

Foursquare needs to prove it is a business

Foursquare’s biggest problem is that it hasn’t been able to generate any meaningful revenue from the millions of users and partnerships it has announced over the past couple of years — according to an anonymous source quoted in the BusinessWeek article, the company had revenue last year of just $2 million, which makes a $600-million valuation look almost ridiculous. According to Crowley, much of the new financing will be used to develop advertising products that can run next to Foursquare’s local recommendations.

Despite its inability to produce revenue, the company’s supporters remain optimistic about its chances of building a truly large-scale and profitable local recommendation service. Hunter Walk, a former YouTube staffer turned venture capitalist, said on Twitter “All I know is the financing allows them to continue building a product I love,” and Shai Goldman of the 500Startups angel fund said: “I hope they figure out how to monetize, I’m a fan.” Even John Lilly of Greylock Partners, which didn’t invest in the company, said on his blog that he thinks Foursquare has a chance to build a real business:

“What does matter is that they raised the money they need to give this a real go. I have high confidence in these guys that they’ll do well and build interesting products and a great business for a long time.”

Others, however, were less complimentary — and many seem to see Foursquare as a high-risk bet, much like email-offer flameout Groupon:

Post and thumbnail photo courtesy of Pinar Ozger