Entrepreneurs borrow between equity funding rounds with a strong record of repaying debts
Lending to cash-burning startups might at first glance seem like a chump’s game. Most lenders want commercial borrowers to show positive cash flow or at least enough liquid assets to cover any debt. Young, venture-backed companies rarely have either.
Yet loans to these companies are on the rise. In a working paper, Juanita González-Uribe of the London School of Economics and UCLA Anderson’s William Mann aim to explain why.
Based on an analysis of more than 1,800 venture loans, along with loan contracts from three of the largest venture lenders, the authors suggest that venture loans have a relatively low risk of default and are nearly always backed by collateral, typically the intellectual property of the borrowers. Venture loans give borrowers a way to cover short-term cash needs and “extend the runway” until the next round of venture-capital investment, which is usually more than enough to repay the debt fully. In effect, it isn’t the seemingly high-risk startup that guarantees the loan. It’s the startup’s deep-pocket venture backers.
“Thanks to the implicit guarantee of a venture capitalist, venture loans achieve remarkably low loss rates on invested capital, despite the high-risk nature of their borrowers,” the authors write.
Venture debt constitutes 15 percent of total venture investments since 2009, according to the authors’ analysis of data from Preqin, a market-intelligence firm. For the 3,400 companies in the Preqin database that have tapped the market, venture debt accounts on average for almost a quarter of their total financing, coming largely between the series A and series D rounds. Annual volume of venture debt was more than $8 billion in 2015 and 2016.