Unsecured Venture Capital
The idea of the unsecured loan has become very popular in new venture financing. Various types of financing, such as non-recourse loans and angel financing are sometimes thought of as unsecured venture capital.
The idea behind unsecured loans is that they are not tied to direct collateral. A non-recourse type of loan means that the liability for the loan is limited to the value of the collateral. This is popular with anyone considering a start up venture, especially if they have considerable assets in other areas. If the venture fails, the liability extends only to the assets of the venture, and the lender has no recourse against the borrowers outside assets.
Actually, most venture capital deals are structured so that they might be unsecured. This is when unsecured is seen as a type of financing that does not have to be repaid in a set fashion. A normal bank loan is generally secured by collateral and a note that requires regular repayment and applies a certain amount of interest. If the repayment becomes delinquent, the note allows the lender to call in the entire unpaid amount of the loan and even possess the collateral to satisfy the debt.
So, when considered this way, venture capital might be considered an unsecured loan since no repayment of the loan is required, or even expected. The purpose of the lender in a venture capital deal is not to merely earn a small amount of interest, but rather to get a favorable equity position in the company. The venture capitalist is looking for a killing on each deal they make.
The dynamics of venture capital deals usually make them very straightforward as far as their structure. People might ask why would a start up company chose venture capital for financing when a secured bank loan would cost less in the long run and they would not have to surrender any control of the venture. The reason is that the company would not chose venture capital if their needs could be met via normal bank financing. The types of companies that are the target of venture capital are those that would not meet the requirements of normal bank financing.
The problem with unsecured loans of any type is that they cost much more in the end. The lender must have some return or chance of return to justify the risk of the unsecured loan. This is one of the most important and basic concepts of financing and investing. If you take no risk, your rate of return will be small. Venture capital does not usually end up costing as much as a regular unsecured loan, because the venture capitalist is willing to share a bit of the risk for a greater share of the potential profit.