Commercial Lending: Venture Loans to Companies in an Early, Expansion, or Late Stage of Corporate Development

The Office of the Comptroller of the Currency (OCC) has issued a new bulletin (2023-34) to provide guidance to OCC supervised institutions related to commercial loans to companies at various stages of development, which the OCC refers to as „venture loans“. These loans typically involve higher uncertainty and a greater risk of default, so the Office. Therefore, institutions engaging in venture lending must do so in a particularly safe and compliant manner with adequate risk management policies and procedures in place to prevent harm. The bulletin now covers background information on venture lending, risks associated with it, risk management practices, and guidance for risk-rating venture loans and assessing repayment capacity. The following text briefly summarizes the key points in each of these areas.
##### Background information
Venture lending is typically associated with early-, expansion-, or late-stage companies, often referred to as „venture borrowers“ or „venture-backed companies.“ The OCC recognizes that venture lending can facilitate new business formation and improve capital access for growth companies, but warns about the higher risks involved due to the likelihood of default or business failure altogether and the absence of established cash flows or collateral.
Not all types of credit are considered „venture loans“ by the OCC. Loans to businesses relying on internal cash flow, government-guaranteed loans, and loans under special-purpose credit programs, for example, are excluded from the definition.
##### Risks associated with venture lending
Venture lending carries specific risks related to the early and expansion stages of companies. These risks include unproven cash flows (no or little experience on cash flow is available), „untested“ business models, difficulties in projecting future cash flows, high liquidity needs, significant investment spending, and limited refinancing or exit options. Borrowers in the early and expansion stages tend to be riskier compared to those in later stages of development, as later-stage companies often have a better chance of generating sustainable cash flow despite significant expenses associated with expansion. Therefore, it’s crucial for lenders to distinguish between venture loans that rely on factors like new product launches, market expansion, rapid growth, or equity fundraising for loan repayment and conventional loans to mature companies with established business models and cash flows. In this context, the OCC also reminds institutions to apply adequate risk mitigation measures and assign a risk rating that corresponds to the risk of default of an appropriate loan.
##### Risks management for venture lending
Due to the inherent risks in venture lending, the OCC emphasizes the importance of establishing operational and managerial standards just for this type of loans. These standards should align with safe and sound practices outlined in the „Interagency Guidelines Establishing Standards for Safety and Soundness“ (12 CFR Part 30, Appendix A and D) and should include, among others, the establishment of lending plans that suit an institution’s size and risk appetite, the hiring of qualified staff experienced in startup lending, the establishment of adequate reporting and monitoring procedures, and the performance of stress test for these loans. Furthermore, the OCC expects proper documentation to support loan decisions and facilitate ongoing monitoring of a loan’s performance.
Regarding risk-based capital treatment, banks should assign a 100 percent risk weight to corporate exposures, including venture loans, unless the credit risk is mitigated by a financially capable guarantor, eligible guarantee, or qualifying financial collateral.
##### Risk-rating venture loans and evaluating repayment sources
When evaluating and risk-rating venture loans, institutions are advised to maintain strong underwriting standards and assess them similar to other commercial and industrial loans. Focus should be on evaluating the borrower’s repayment capacity, emphasizing its expected performance, historical performance, reliability of cash flow projections, and various other factors influencing its ability to generate cash flow for debt repayment.
As far as the evaluation of repayment sources is concerned, the OCC only considers current and future cash flows sufficient to cover fixed charges and debt repayment and adequate collateral as vital sources of capital. Potential future venture capital fund raising or the use of unrestricted credit lines is NOT considered adequate financial resources for purposes of loan repayment. In this context the OCC also warns that recurring revenues should not be considered to be equivalent to sustainable repayment capacity.
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To conclude, the OCC notes that this bulletin does not apply to asset-backed lending as this type of lending is secured by appropriate collateral furnished by the borrower.