What are the risks of working with a new venture lending firm?

There are always new lenders entering the Venture Lending industry because the yields are very attractive and the equity upside derived from big warrant hits can be huge.

However, Venture Lending is a difficult business. By definition, you are lending to risky companies that are losing money. Many new entrants make the mistake of thinking the venture capitalists will bail out the company, and by extension - the company. However, VC’s hate writing a check to a company, only to have the proceeds go to pay back the lender. A lender must underwrite a loan to a startup based on the company’s ability to attract future equity capital and the lender’s ability to add structure to the deal to protect themselves.

New entrants, or “tourists,” are dangerous until they prove to be a good lending partner long term. At first, the new entrant will only see the deals that everyone passed on. The only way to win good deals without a strong reputation is to under price the risk and offer borderline crazy terms.

The tourists usually come from a tougher brand of lending and rely on covenants, MAC clauses and minimum cash requirements to get their cash back in downside scenarios. They tell themselves it’s ok to under price the risk and take on too much exposure because they can always maneuver to get their money back.

However, when the tourists start having deals go bad and they try the hardball playbook of sweeping cash and locking up the company, things get worse. This tactic accelerates the company slide and everyone loses. Word spreads quickly in the VC & Entrepreneur communities. Then no one in their right mind will do a deal with the lender and they are left with a portfolio of under priced loans to poor companies and no ability to grow their way into profitability because they have ruined their reputation.

At that point they elect to get out of the business and become an even worse partner because they only care about getting their capital back as soon as possible. It’s a negative cycle that can hurt a healthy company.

I’ve seen this cycle play out many times and it’s always the same story. In Venture Debt, stick with the established players with good reputations. The principals may go to different firms or start their own firm, but wherever they go, they will protect their reputation by working with companies through tough times. If your startup is looking to bring on venture debt, learn more about venture debt by watching our video on how to raise debt.