The Leveraging of Silicon Valley: Venture Debt in the Innovation Economy

52 Pages Posted: 30 Jul 2018

See all articles by Jesse Davis

Jesse Davis

University of North Carolina (UNC) at Chapel Hill - Finance Area

Adair Morse

University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER)

Xinxin Wang

University of North Carolina (UNC) at Chapel Hill - Finance Area

Date Written: April 1, 2018

Abstract

Venture debt is now observed in 28-40% of venture financings. We model and document how this early-stage leveraging can affect firm outcomes. In our model, a venture capitalist maximizes firm value through financing. An equity-holding entrepreneur chooses how much risk to take, trading off the financial benefit against his preference for continuation. By extending the runway, utilizing venture debt can reduce dilution, thereby aligning the entrepreneur's incentives with the firm's. The resultant risk-taking increases firm value, but the leverage puts the startup at greater risk of failure. Empirically, we show that early-stage ventures take on venture debt when it is optimal to delay financing: such firms face higher potential dilution and exhibit lower pre-money valuations. Consistent with this notion, such firms take eighty-two fewer days between financing events. This strategy induces higher failure rates: $125,000 more venture debt predicts 6% higher closures. However, conditional on survival, venture debt-backed firms have 7-10% higher acquisition rates. Our study highlights the role of leverage in the risking-up of early-stage startup firms. Aggregation of these tradeoffs is important for understanding venture debt’s role in the real economy.

Keywords: Corporate Finance, Entrepreneurship, Venture Capital

JEL Classification: G24, G30, G32

Suggested Citation

Davis, Jesse and Morse, Adair and Wang, Xinxin, The Leveraging of Silicon Valley: Venture Debt in the Innovation Economy (April 1, 2018). Kenan Institute of Private Enterprise Research Paper No. 18-16, Available at SSRN: https://ssrn.com/abstract=3222385 or http://dx.doi.org/10.2139/ssrn.3222385

Jesse Davis

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Adair Morse

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Xinxin Wang (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

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