When tech founders run low on cash, standard industry practice often points toward pitching venture capital firms for equity. Giving away company shares, however, dilutes the founders’ ownership and can permanently reduce their operational control. To postpone that equity sacrifice, many growing businesses turn to venture debt, borrowing funds rather than selling off equity.
A study published in the International Review of Economics and Finance examined how the rise of this borrowing mechanism influences the wider distribution of capital across technology ecosystems. David Dekker of Heriot-Watt University and his colleagues found that venture debt alters the flow of venture capital across different phases of business growth. Their analysis shows that venture debt availability is linked to a reduction in early-stage equity funding, while simultaneously expanding equity deployment for late-stage companies.
A Specialized Instrument in Tech Finance
Commercial banks typically hesitate to lend to young technology enterprises because early ventures burn through cash reserves and lack physical assets, such as machinery or real estate, to pledge as loan security. Venture debt fills this financing gap by providing short-term loans specifically designed for fast-growing companies that have already secured institutional venture capital backing. Lenders manage default risk by taking warrants, which are legal rights to purchase company shares at a prearranged price, or by securing patents as collateral.
Historically, venture debt served primarily as a niche bridge loan between funding rounds in the United States. Global venture debt volume surpassed $43 billion in 2024, supported by specialized private debt funds and state agencies like the European Investment Bank. Dekker, alongside co-authors Vanessa Galeano-Duque from Heriot-Watt University and Dimitris Christopoulos from Heriot-Watt and Modul University Vienna, set out to test whether venture debt simply supplements existing pools of money or actively changes how investors allocate equity.
Tracking Capital Across 59 Countries
To evaluate these financial dynamics, the researchers compiled an international dataset covering 59 countries from 2015 to 2024. Using data from the analytics platform TRACXN, they assembled records on seed financing, public innovation grants, early-stage equity, late-stage equity, and venture debt flows. The research team merged these figures with macroeconomic data from the World Bank, including national gross domestic product and political stability indicators, as well as patent output data from Lens.org.
The authors evaluated the records using a panel vector autoregression model. This statistical method allows researchers to observe how multiple financial streams interact and influence each other dynamically over time, rather than treating any single stream as fixed. The team incorporated past values of seed capital and public research grants, while controlling for broader market indicators like patent volume per inventor and national income levels.
The underlying data presented clear structural nuances. While 59 countries provided sufficient baseline data, regular venture debt transactions were heavily concentrated in 15 markets, including the United States, the United Kingdom, Canada, Germany, India, and Singapore. The researchers acknowledge this sparse venture debt data as a key limitation of the analysis, noting that more comprehensive data would allow future research to apply alternative empirical strategies and richer specifications.
Trade-Offs Across the Startup Lifecycle
The findings indicate that venture debt operates in two opposing directions depending on a firm’s level of development. In early stages, venture debt acts as a substitute for equity investments. When venture debt becomes more readily available in an economy, early-stage equity funding tends to fall, with the statistical estimates showing a reduction of about two dollars of early-stage equity for every dollar of venture debt introduced.
At later stages, this relationship flips into a complementary pattern. Increased venture debt availability is linked to a rise in late-stage equity funding, expanding late-stage investment by roughly four dollars for every dollar of debt. Because the late-stage gains outpace early-stage reductions, the net impact of venture debt on total ecosystem funding remains positive over time.
The researchers interpret this pattern as a lifecycle capital reallocation. For early-stage companies, borrowing enables founders to extend their operating runway and hit technical milestones without facing immediate equity dilution or valuation negotiations. Early venture lenders often extend these loans because they expect existing venture capital sponsors to protect their own investments by supplying future funding rounds. This mechanism, the authors argue, allows venture capital funds to conserve their money early on and redirect capital toward proven, revenue-generating businesses that require substantial expansion capital.
The Hidden Costs of Replacing Early Equity
Although this shift improves overall capital efficiency, the researchers identify important tradeoffs for younger companies. Early-stage venture capitalists provide valuable non-financial resources, including industry introductions, strategic governance, and active mentorship. When young firms substitute early equity with loan facilities, founders keep their ownership stakes but may miss out on the hands-on operational guidance that experienced startup investors provide.
Loans also introduce fixed repayment obligations that can strain early ventures if product development slows down or customer adoption lags. Later-stage borrowers face a different set of financial pressures, as lenders evaluate mature companies on commercial cash flow and operational stability rather than the likelihood of another venture capital check.
The authors suggest that policymakers should avoid viewing venture debt as a universal fix for entrepreneurial financing gaps. In nascent tech hubs where early-stage equity networks remain underdeveloped, an influx of debt could inadvertently suppress early-stage equity without providing an adequate safety net. The researchers argue that government initiatives in developing ecosystems should balance venture debt incentives with matching schemes and seed co-investment vehicles to protect early business creation.
The study carries several empirical caveats. The model calculates an average relationship across the international sample, meaning specific effects could differ in countries with distinct legal systems or banking cultures. The framework also treats venture debt availability as largely external to concurrent equity fluctuations, though broad macroeconomic shifts could influence both instruments at the same time. The authors suggest that future investigations should analyze company-level performance records to determine whether startups funded partly by debt match the long-term survival rates of those financed entirely through equity.
