The Unwarranted Fear Of Venture Debt: Dispelling Unconscious Biases In Startup Financing

Venture capital has long been the oxygen that fuels the growth of start-ups, yet it comes with its own share of drawbacks, primarily in the form of equity dilution. Founders find themselves giving up more control with each funding round and progressively distancing themselves from the very companies they brought to life. Here lies the paradox in modern startup financing: despite the availability of venture debt—a less dilutive alternative—many companies hesitate to leverage it. This is influenced by antiquated biases and a deep-seated aversion to debt. And this unfounded fear, steeped in historical precedents and cultural narratives, needs to be acknowledged and reevaluated. 

Debt, in its essence, is often viewed through a prism of skepticism and fear. This perspective is not new. Historical texts and teachings, such as those found in the Bible, have long warned against the perils of debt. Proverbs 22:26-27 advises against becoming “one of those who enter agreements, who put up security for loans,” cautioning that failure to repay can lead to dire consequences. While these admonitions were apt in an era when financial systems were rudimentary and punitive, they are less relevant in today’s sophisticated economic environments. Yet, these ancient warnings continue to color the perceptions of debt in the modern corporate psyche—discouraging its use even when it could serve a beneficial purpose.

Venture debt is designed to complement venture capital as a strategic instrument to minimize equity dilution, especially for companies that possess a clear path to profitability. It allows founders to retain more control over their company while still securing the necessary capital to grow. Despite this, the startup ecosystem remains wary, and the roots of this wariness lie not only in historical prejudices but also in a lack of understanding of venture debt’s potential benefits and its operational mechanics.

The reluctance to embrace venture debt is particularly perplexing given its advantages. It is typically structured with the unique needs of the company in mind, and it does not necessitate the surrender of board seats or the relinquishing of significant control over strategic decisions—a critical consideration for founders who wish to steer their venture’s direction.

The bias against venture debt often reflects a broader hesitancy towards any form of debt, fueled by high-profile failures and bankruptcy tales that captivate public attention much more than narratives of prudent debt management and success. However, such views overlook the myriad successful ventures that have harnessed debt judiciously to navigate growth phases while safeguarding founder control and stakeholder value. In these cases, debt was most appropriate (and useful) for only the strongest companies with clear paths to profitability or exit.

The collapse of Silicon Valley Bank (SVB) provides a key example in this light. When it failed in March 2023, it not only impacted the startup ecosystem’s bank accounts but also severely diminished the credibility of venture debt among those unfamiliar with the bank’s lending practices. In short, SVB was the preeminent bank that provided credit to really early-stage companies based on their venture capital sponsors rather than their business metrics or fundamentals. This approach made their loans inherently risky (compared to late-stage loans), as these companies often lacked the typical metrics or collateral required for underwriting. Nonetheless, the spotlight of SVB’s collapse led many to believe that all players in the venture debt community issued similar high-risk loans despite the truth being the opposite of SVB’s model.

What is needed today is a cultural shift within the startup community towards a more nuanced understanding of financial instruments, especially venture debt, and education as well as successful case studies can play pivotal roles in this transformation. Founders must also critically assess their financing strategies and weigh the long-term risks of equity dilution against the potential benefits of venture debt. By highlighting examples where venture debt has enabled startups to thrive without the heavy cost of equity dilution, the industry can begin to dismantle outdated perceptions.

Overall, the startup community must awaken to the reality that unconscious biases extend into financial instruments and capital raising practices. Embracing venture debt could well be the key to a new era of startup financing where founders maintain greater control and companies are unburdened by the heavy yoke of unnecessary dilution.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.

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