Liquidity Runway and Horizon of Disappointment: Business Model of Venture Lending

Hesse, M, Lutz, E and Talmor, E (2016) Liquidity Runway and Horizon of Disappointment: Business Model of Venture Lending. Journal of Alternative Investments, 19 (2). pp. 28-37. ISSN 1520-3255

Abstract

This article discusses venture debt as an important source of funding for young innovative firms, one that is rooted in a unique economic model. The authors present a detailed analysis of the concept and its multiple elements. Through unique access to deal-level data from a European venture lending fund, they underline the analysis with empirical data to explain the interdependencies among venture lenders, start-ups, and venture capitalists and how missing track records, tangible assets, and positive cash flows can be substituted in venture lending deals. Their results suggest that venture capitalists as well as intellectual property play a crucial role in the venture lender’s decision by signaling attributes of the start-up to the lender. The authors outline the risk-reduction instruments applied by the venture lender in mitigating default risk despite high volatility and a lack of conventional collateral. They then link this to the concept of the J curve, in which the authors use insights from option-pricing theory to rationalize the security design.