Lending mechanisms in India revolve around collateral, business models and revenue generation â€” neither of them a startup‘s biggest strength. This is where venture debt firms step in, helping startups to sustain operations till they get equity funding.
In 2012 when Snapdeal’s growth counters had just begun to ring, its founder Kunal Bahl was scouring the market for funding as his business was burning cash and profitability seemed far away. He had the likes of eBay Inc lined up to infuse capital but the gentleman chose to bide time. The reason was simple — Bahl wanted to better the company’s gross merchandise value and customers, which, in turn, would fetch the e-commerce marketplace a higher valuation.
That’s when InnoVen Capital (then SVB India Finance) came to Bahl’s rescue. He secured a USD 1.5-million loan from SVB India Finance, and more importantly, it bought him the time to find an equity partner. Soon after, in June 2013, Snapdeal raised around USD 50 million from eBay and others at a valuation of around USD 500 million.
“Venture debt helps companies accelerate growth to increase enterprise value ahead of the next equity round,” said Ajay Hattangdi, Group Chief Operating Officer and Chief Executive India, InnoVen Capital.
“The company (Snapdeal) was close to raising its next round but figured it could benefit from some additional capital ahead of the round as a way of extending its liquidity runway. The advantage that the debt provided was borne out by the fact that the company came back to us the subsequent year for yet another debt tranche in a very similar situation,” he told moneycontrol.com.
Snapdeal declined to comment for this story.
Since 2008, InnoVen Capital has provided over 115 loans to more than 80 early and mid-growth stage startups, including Byju’s, Snapdeal, Freecharge, Myntra, Practo, Portea, Voonik and Manthan Systems. Its term loans range from Rs 3 crore to Rs 30 crore.
Trifecta Capital is another company which offers venture debt. Its portfolio companies include Urban Ladder, IDfy and Rivigo.
The rise of venture debt
Most banks and non-banking financing companies aren’t comfortable lending to startups. Lending mechanisms in India revolve around collateral, business models and revenue generation — neither of them a startup’s biggest strength. This is where venture debt firms step in, helping startups to sustain operations till they get equity funding.
Another advantage venture debt offers is it protects ownership by giving entrepreneurs an opportunity to avoid stake dilution.
Apoorv Ranjan Sharma, Co-founder and President, Venture Catalysts, highlighted that venture debt is an attractive way to finance a business with less dilution than equity. “It does not require a valuation to be set for the business. Additionally, venture lenders generally don’t take board seats and have few governance requirements,” he said.
Sharma, however, cautioned that there is no “one size fits all” approach to venture debt. Some common factors that entrepreneurs should bear in mind while raising venture debt, he said, are: “a) generate sufficient cash flows to service debt; b) need a medium term inflow to achieve next round milestone c) avoid dilution of equity; and d) fund specific projects”.
Hattangadi of Innoven Capital said the best time to productively use debt is when the startup either achieves some level of business stability or when it raises its first serious round of institutional capital. “While a company could theoretically benefit from taking debt at any stage, leverage should not be taken until the startup has achieved a certain level of resilience in managing the turbulence of its early growth period,” he said.
Mumbai-based movie discovery platform Flickstree's founders believe that it is fundamentally important for startups to show stability in business growth before looking out for venture debt.
Saurabh Singh, Chief Executive of Flickstree, which is in talks with investors for raising funds, said: "Fundamentally, for newly-launched startups, a debt is avoidable as it is a liability. It is important for startups to show growth to angel investors both through revenue and in subsequent rounds of funding."
Flickstree is trying to take advantage of the clampdown on torrents by offering users a curated catalog of movies from various sites such as Netflix, Apple iTunes, through its website and Facebook bot.
Beware of debt trap
While venture debt can be a saviour, some experts say, it can be a curse as well. Bijesh Amin, co-founder of Indus Valley Partners — a specialist technology solutions firm focused on Alternative Asset Management — terms the spurt in venture debt a short-term phenomenon.
"Opportunities for making money globally are increasingly becoming hard to find. Going ahead, it won't be just angel investors or venture capital firms who would finance startups. It will also be private equity funds, hedge funds, institutional investors. They will be more interested in taking equity ownership in return for financing — that's where they see returns," Amin said.
Though a lot of startups are adopting this method, where are the yields, Amin asked. Yields are falling and investors want healthy returns. He cautioned startups from falling into a debt trap. Since there is no collateral involved, entrepreneurs may overburden themselves with loans which they can’t service ultimately, he said.
Amin said startup leaders should, instead, diversify and look for alternate means of fund-raising through both domestic and foreign investors. They should realise that there’s a broad spectrum of financing options available and accordingly identify sources.
“VCs can use venture debt to improve their returns by ensuring that they optimise investments and reserve capital for more companies. Venture debt is an intrinsic part of the venture ecosystem and we are optimistic about the future of venture debt as the overall environment for venture capital continues to strengthen,” Hattangadi of InnoVen Capital said.
Though startups and venture funds are warming up to venture debt, this form of new-age lending has a long way to go. From the signs that the Indian startup sector is exhibiting, there is little doubt that venture debt can be the bridge between two rounds of fundraising by startups.