Venture Debt Financing: Determinants of the Lending Decision

Abstract

Research summary: Venture debt lending is a form of start-up financing that lies at the intersection of venture capital and traditional debt. We analyze the lending decision criteria of 55 senior U.S. venture debt lenders (VDLs) using a discrete choice experiment in order to understand how VDLs overcome barriers that traditionally hamper start-ups' access to debt. We find, first, that the provision of patents as collateral is as important as the provision of tangible assets to lenders. Second, VDLs showed a marked preference for start-ups that offered warrants. Third, venture capitalists' backing substitutes for a startup's positive cash flows.Managerial summary: This article provides insights into the business model of venture debt lenders. Venture debt is an equity efficient way to raise money: it limits equity dilution by prolonging runways and allowing entrepreneurs and investors to raise equity at the next funding round at a higher valuation. The research suggests that venture debt plays an important role in new venture financing, with about one venture debt dollar provided for every seven venture capital dollar invested. It further suggests that backing by venture capitalists (VCs) and the provision of patents as collateral significantly increase the chance of obtaining venture debt. Therefore, it provides additional rationales for having VCs onboard and for applying for patents. More generally, the research illustrates that debt, in the form of venture debt, is available to start-ups with negative cash flows and no tangible assets.

New players in entrepreneurial finance and why they are there

“…They provide loans to start-ups, but unlike traditional bank, financing do not require securities or positive cash flows from start-ups. De Rassenfosse and Fischer (2016) estimate the size of the US venture debt market at about $3 billion per year. Internationally, there is little relation between institutional factors such as legal conditions and venture debt returns (Cumming and Fleming 2013;.…”

Innovation with Limited Resources: Management Lessons from theGermanMittelstand

“…Entrepreneurial finance (Dushnitsky and Shapira, 2010;Fraser, Bhaumik, and Wright, 2015;Rassenfosse and Fischer, 2016;Wu, Si, and Wu, 2016) RQ #6B: What organizations are best suited to provide the resources-such as financial resources-mentioned in the resource-based model of the Resource-based view and resource management and orchestration (Barney, 1991(Barney, , 2001Sirmon et al, 2007Sirmon et al, , 2008Sirmon et al, , 2011Sirmon, Hitt, Arregle, and Campbell, 2010 cannot guarantee success. In this sense, the striking success of the Mittelstand is reminiscent of the current interest in research on clusters, and spatial systems of innovation, with their emphasis on a broader context involving multiple partners, (entrepreneurial) ecosystems (Clarysse, Wright, Bruneel, and Mahajan, 2014), and factor inputs and institutions in shaping economic performance.…”

The Evolving Entrepreneurial Finance Landscape

“…These developments include peer‐to‐peer lending through crowdfunding platforms as well as venture debt. Venture debt lending lies at the intersection of venture capital and traditional debt, providing a mechanism to raise money that limits equity dilution by allowing entrepreneurs and investors to raise equity at the next funding round at a higher valuation (de Rassenfosse and Fischer, , this issue). These new forms serve to enhance further the heterogeneity of the traditional dichotomy between debt and equity in entrepreneurial finance but also to blur the lines between the two forms by introducing new varieties of quasi debt and equity as well as rewards and donations.…”