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This Article develops a unique theory of performance-sensitive debt and argues that certain revenue-stage startups may be missing out on an important source of capital from asset-based loans. Debt contracts are performance sensitive to the extent any of the borrower’s obligations adjust in response to the performance of the borrower. The three main types of performance sensitivity I identify are (1) a loan’s interest rate adjusting based on the performance of the borrower; (2) the amount of available credit adjusting based on the value of collateral; and (3) renegotiation following breach of a loan covenant. Conceptualizing performance sensitivity as a separate governance mechanism allows me to flesh out, and in some cases challenge, several distinct bodies of research, including incomplete contracting theory and the literature on capital structure.

The focus of this Article is on the nature of one type of performance-sensitive debt in particular — asset-based loans. Asset-based loans are important because they are the only type of loan that adjusts the amount of credit available to a borrower based on the performance of its assets. Due to the protections asset-based loans provide to lenders, they are often the only type of loan lenders are willing to make to high-risk borrowers. Asset-based loans are often cheaper than other sources of capital, more borrower-friendly than other types of debt, and can be structured to meet the needs of a wide variety of borrowers. Because of these characteristics, I argue that certain revenue-stage startups, including those with intellectual property assets, may be better off raising capital with asset-based loans than other types of financing.