The question whether a start-up should rely on commercial bank financing (if obtainable) is to be approached quite cautiously. A commercial bank can make a very poor partner for a fledgling enterprise; the lenders tend to want their money back at just the wrong moment. Often the only type of bank financing available to a startup is a demand note secured by a floating lien on all the assets of the operation and the personal signature of the founder, a dangerous weapon in the hands of a nervous bank. Moreover, bank lending to early-stage, high-tech companies is on occasion the result of a fashionable wave in banking circles, the thought being that banks should get in on the "new" game by incubating clones of Wang Laboratories through judicious extensions of credit to deserving entrepreneurs. The first problem is that only a limited number of commercial banks are staffed with loan officers with the necessary experience to discriminate among applicants in an area of lending where standard rules of thumb and guidelines are out the window. (There are, of course, significant exceptions.) Moreover, as fashions come, so fashions go. Long-time players in the venture-capital game can cite a number of unfortunate instances when senior bank officers, focusing on a well-publicized disaster in the high-tech business generally, have given the generic order to the lending division to "tighten the screws." The problem, of course, is that start-ups are very fragile animals; the slightest hiccup in a bank, or any relationship, can strangle the baby in its crib, so to speak. Even more tragic are instances where the bank becomes nervous about the loan in the early stages of a start-up's career, when earnings are following the well-known "hockey stick" path (i.e., trending downward for a number of periods, usually at least one full year longer than the projections suggest, followed by a sharp "ramp up" once the company breaks through). The bank's anxiety having been excited by the long slide downward, it springs the trap by cutting off credit and marshaling assets at the very point when the company's good news is just beginning. There are, to be sure, banks and there are banks. Some banks, particularly those located in the classic high-tech areas, have become experienced in lending to early-stage companies and are less likely to panic. Indeed, some banks are willing to negotiate compensation for their added risk by accepting equity in the borrower—an equity "kicker"—or an interest rate tied to a fixed base or index plus increases, depending on the fortunes of the borrower
Two Sources of Repayment (The Traditional Credit Model)
Two Sources of Repayment (A Variation on the Theme–venture lending)
Source for bullet lists: How Venture Lenders Value IP, Brad Holt, Silicon Valley Bank.