Debt as Venture Capital
Darian M. Ibrahim | 2010 U. Ill. L. Rev. 1169
Venture debt, or loans to rapid-growth start-ups, is a puzzle. How are start-ups with no track records, positive cash flows, tangible collat-eral, 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 ven-ture capitalists (VCs), as well-known capital structure theories from cor-porate finance would seem to predict in this context? Using hand-collected interview data and theoretical contributions from finance, eco-nomics, and law, this Article solves the puzzle of venture debt by reveal-ing 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 entrepre-neurs, angels, and VCs avoid dilution, improves VC internal rate of re-turn, assists VCs in monitoring entrepreneurs, and follows from capital structure theories after the first round of VC funding.