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With the liquidity crisis facing the Indian economy, banks, financial institutions and corporates are finding it increasingly difficult to raise capital. However, the venture debt segment seems to remain immune to this trend and is gaining traction among startups as a potent source for financing their ventures.
Venture debt works on similar lines as regular bank loans but is accessible even without tangible assets to provide as collateral. So, even not so creditworthy startups can seek venture debt funding. These debts come with a fixed tenure, interest rates and repayment schedules after an initial moratorium phase. But they do not dilute equity and are a great bridge between traditional debt and venture capital for startups. Even though venture debt has been around since the early 2000s in India, it has gained traction only in recent years as startups see this as a less complex financial instrument to fund their financial needs. We will delve deeper into the reasons a little later in the article. Let us now take a closer look at how venture debt has risen in popularity in recent years.
A number of big venture debt players have entered the Indian ecosystem in the past few years and this has marked a pivotal point in the rise of this form of funding. The liquidity crisis has only further accelerated the growth of venture debt in Indian startups. These venture debt players include InnoVen Capital owned by Singapore Government’s investment firm – Temasek (and one of the first entrants in the space), Mumbai-based Alteria Capital, Trifecta Capital, etc.
The entry of seasoned entrepreneurs and investors like Azim Premji Foundation, Flipkart founders – Sachin Bansal and Binny Bansal, Kiran Reddy, etc. and banks like RBL, IndusInd, SIDBI, etc. as anchor investors of the venture debt firms have strengthened and brightened the space immensely. The main reasons for the entry of such big names as anchor investors in the space are:
The quantum of venture debt funding and the number of debt capital deals in India have grown over the years mainly because of the fast-growing startup ecosystem. Put differently, there is a much larger startup pool in India to invest debt capital in. In 2017, 47 venture debt deals worth USD 1.2 billion were closed. This increased to 62 deals worth USD 1.4 billion in 2018. In H1 2019, nearly 35-40 venture debt deals worth the USD 547 million were closed.
Other famous growth-stage and mature-stage startups that raised venture debt in the past three years include Paper Boat, OYO rooms, Urban Clap, Ninjacart, Rivigo and Vogo among others.
Venture debt is viewed as a less complex means to serve the strategic financial needs of the startups in an expedited manner. As mentioned earlier, venture debt firms have a greater capability to recycle funds and they also receive greater quantum of anchor funds owing to lesser risk and losses involved. So, venture debts are more accessible for startups – early-stage, growth-stage and mature startups – whether for initial funding or follow-on rounds.
Venture debt can be borrowed even by startups with lower creditworthiness unlike traditional loans and without collateral. So, even early-stage startups who are asset-light and with lower creditworthiness can access venture debts. Venture debts are provided to startups based on their idea and business, Proof of Concept, IP rights, etc. and the IP rights, forms of receivables, etc. are often the collateral for this form of funding.
Inability to raise sufficient equity capital is another reason, especially for startups, to look towards debt capital. In India, equity funding for early-stage startups has slowed down in the past 2 years with fewer such deals being closed. It is the unicorns and growth-stage startups that have received the largest quantum of the equity capital raised in the country in this time period.
For mature and growth-stage startups, equity capital causes loss of control and equity dilution for co-founders. They may not be in a situation to have further equity dilution and therefore, look towards debt capital for follow-on funding and late-stage funding. This is because the cost of debt capital is a monetary one - the interest the startups pay and does not cause any equity dilution.
Overall, venture debts essentially bridge the gaps between equity capital and traditional debt capital.
Even as debt capital gains more traction among startups, it is important to note that venture debt is not a replacement for equity financing but a supplementary source of strategic funding.