Venture Debt Financing: Determinants of the Lending Decision

Abstract

Research summaryVenture 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 start‐up's positive cash flows.Managerial summaryThis 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. Copyright © 2016 Strategic Management Society.