Xuan-Thao Nguyen and Erik Hille, Disruptive Lending for Innovations: Signaling Model and Banks Selection of Startups Innovations, 21 U. Pa. J. Bus. L. 200 (2018), https://digitalcommons.law.uw.edu/faculty-articles/863
Disruptive Lending for Innovations: Signaling Model and Banks Selection of Startups Innovations
Startups desperately need funding. But lending to startups is too risky for banks. How can banks lend to startups whose cash flow is negative, tangible assets are nonexistent, and most valuable assets are patents? In light of the uncertainties, what can banks do in lending for innovations? In this Article, we turn to economic theory to demonstrate how banks can make their selections of startups, ensuring their returns and encouraging innovations. Specifically, we create a signaling model with partial separating equilibria to demonstrate how banks can address the information asymmetry problem by relying on a truth-telling signal in assessing the likelihood a startup firm will obtain subsequent rounds of capital funding. The model is consistent with evidence from publicly available sources.