July 06, 2009
Venture Debt
Posted by Gordon Smith

I have written about venture equity capital, and I have often wondered about venture debt, a seldom studied corner of the venture industry dominated by Silicon Valley Bank, along with smaller providers Comerica and Square 1. I have read an occasional news story or blog post about venture debt, but I was thrilled to read Darian Ibrahim's latest effort, Debt as Venture Capital. It's a fascinating examination of these transactions based on interviews with venture professionals. Here's the abstract:

Venture debt, or loans to rapid-growth start-ups, is a puzzle. How are start-ups with no track records, positive cash flows, tangible collateral, or personal guarantees from entrepreneurs able to attract billions of dollars in loans each year? And why do start-ups take on debt rather than rely exclusively on equity investments from angel investors and venture capitalists (VCs), as well-known capital structure theories from corporate finance would seem to predict in this context? Using hand-collected interview data and theoretical contributions from finance, economics, and law, this Article solves the puzzle of venture debt by revealing that a start-up’s VC backing and intellectual property substitute for traditional loan repayment criteria and make venture debt attractive to a specialized set of lenders. On the firm side, venture debt helps entrepreneurs, angels, and VCs avoid dilution, improves VC internal rate of return, assists VCs in monitoring entrepreneurs, and follows from capital structure theories after the first round of VC funding.

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