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What is Venture Debt: The New Way to Fund Startups in India

Professor of Financial Economics and Part-time Value Investor, Transfin.
Oct 30, 2018 11:21 AM 3 min read
Editorial

Opting solely for Venture Capital (VC) for startups means dilution of ownership and control.

 

Against this backdrop, Venture Debt or Venture Lending is emerging as a powerful alternate for a certain category of Indian startups.

 

Venture Debt can act as a viable financing option for certain early-stage and growth-stage “VC-backed” startups.

 

The idea behind Venture Debt is to extend debt to VC-backed companies which don’t have access to traditional debt (from commercial banks, NBFCs etc.).

 

The reason why “VC-backed” companies are preferred for Venture Debt is their comparatively low failure rate in comparison to an “unbacked” start-up.

 

A Venture Debt financing does not set an equity valuation for the company – a particularly helpful proposition ahead of a new round of equity financing, before a potential sale etc.

 

Venture Debt emerged in the US more than 30y ago and is now estimated to be a $2bn-$3bn market. Notable companies that have raised Venture Debt include Facebook, YouTube, MySpace and Athena Health.

 

In Europe this asset class emerged more than 20y ago and is estimated to be sized over and above $1bn annually. Noteworthy examples in Europe include SoundCloud and Codemaster.

 

With many start-ups in India now maturing, Venture Debt as an asset class is becoming sizeable.

 

Over the years, the Indian startup ecosystem has created companies with the potential to generate enough cash flows and raise debt.

 

Case-in-point may be a host of Venture Debt funds such as Innoven Capital, Alteria Capital, Trifecta Capital which are looking to raise well over INR2,500-2,800cr cumulatively in 2018. They, alongwith Unicorn India Ventures and IvyCap Ventures are some firms which extend Venture Debt financing to startups at Series B and Series C stage in India.

 

Some noteworthy companies to raise capital this way includes BigBasket, Snapdeal, Faasos, Myntra, Freecharge, Practo, Yatra, UrbanLadder, OYO Rooms, Byju’s, Swiggy, Zoom Car, Helpchat and UrbanClap.

 

Ticket sizes have grown from INR5cr-10cr to well over INR50cr across startups such as BigBasket, OYO Rooms, and even INR100cr in Yatra.

 

Funds preferably invest only in VC backed start-ups and have raised Series-A and Series-B round of capital.

 

It offers minimal dilution and less operational involvement. It is often structured as a Bridge Round.

 

Venture Lending enables startups to fuel growth with minimal dilution and less operational involvement of venture capitalists.

 

With more ownership to keep, promotors can position and command a better valuation.

 

Venture Debt assists startups with an extended runway, especially between funding rounds, or maintain their current runway without losing out on unplanned expansion opportunities.

 

Best time to raise may be between equity rounds, to fund capital heavy investments, pre-IPO etc.

 

As discussed, Venture Debt can provide startups with an extended cash runway ahead of the next equity round, resulting in a higher valuation and less equity dilution.

 

Therefore, immediately after or between equity rounds is a suitable time for startups to seek Venture Debt funding.

 

It can also help startups finance immediate and capital heavy investments, be successfully used to propel growth, and minimize or eliminate the need for equity financing.

 

It is an effective tool to finance acquisitions or strengthen one’s balance sheet before an IPO, strategic partnership or an M&A situation.

 

Considering Venture Debt is unsecured / lightly secured ‘risk’ money, the cost of capital sits lesser than equity but higher than traditional debt. A lot depends on structuring.

 

Venture Debt, in terms of cost of capital (or interest rate) typically comes at 17-18% plus as per industry experts.

 

Repayment of principal and interest are in general repaid monthly. The lender often takes warrants which would provide the firm with an option to buy the company’s shares at a discounted price at the next round of equity investment.

 

If the borrowing company has a liquidity event in the form of an IPO or a buyout, an equity “kicker” could be incorporated to allow the lender to make additional returns to compensate for the higher risk.

 

Considering the lender is not a “shareholder”, they do not dictate the uses of funds.

FIN.

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