Lending-focused startups corner a third of funding this year as pure tech deals dry up

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Lending-focused startups have dominated private equity and venture capital funding so far this year as investors have stayed away from pure technology-oriented deals amid a worsening funding winter.

Firms that have lending as one of their key offerings have raised close to $850 million in funding in the first two months of 2023, according to data collated by Moneycontrol through Tracxn. This makes up for nearly a third of the total funding of $3.04 billion raised by all startups across sectors during the period, the data showed.

Some of the largest deals that have happened so far this year have been in the lending space. For instance, personal loan platform KreditBee raised $120 million in January, followed by PhonePe, which has raised $450 million across two rounds so far this year and announced raising $1 billion in total. To be sure, PhonePe does not have lending on its platform yet but the Walmart-backed company said it will use the raised funds to add lending to its offerings.

The lending edge

“Lending at scale tends to be a juggernaut in India because we are such a credit-starved country,” said Piyush Kharbanda, general partner, Vertex Ventures.

“It is not easy to monetise lending. But it's easier to run a business once you have solved some core problems (for lending) and gotten to scale. So lending businesses start to look attractive at scale and that’s why if you look at private equity investors or buyout investors, almost all of them have a large lending business in their books,” he added.

Moreover, the market size of digital lending, currently pegged at $270 billion, is expected to hit $1.3 trillion by 2030, according to a report by Inc42. Digital lending is also set to account for 60 percent of the total Indian fintech market by 2030, the report said.

Many startups, thus, tend to make forays into lending, especially after establishing a brand through other services such as payments or wealth management, just as PhonePe announced adding lending to its product range after becoming a household name for payments.

“It is easier to lend to somebody than borrow from them. If somebody is willing to give you money, you will take it. When the customer is receiving money, they don't need a high level of trust. They will need a high level of trust when it comes to parking their money, investing, or using them for wealth advisory or wealth management. Hence, payments and lending are easier ways to acquire customers because you are providing them with a service,” said Ankur Mittal, co-founder, Inflection Point Ventures.

“Even once you have captured a customer, how will you become profitable? You will become profitable only by improving your lifetime value (LTV). For that, you will have to diversify and add more products. So if you have a captive audience, and on top of your core offerings to them, you can successfully cross-sell and upsell, that is how you become profitable,” he added.

Amid regulatory tussle

Interestingly, the pace of dealmaking in the digital lending space has picked up at a time when the sector is in the midst of a regulatory tussle. In the recent past, the Reserve Bank of India and the Ministry of Electronics and Information Technology (MeITY) have cracked down on digital lending applications due to concerns over “national security”. In February, the MeiTY blocked 94 ‘unregulated’ loan apps over alleged links to China.

“People who play fast and loose with regulation struggle in India because they think that they can get around regulatory frameworks, but that is not the way Indian regulators work,” said Kharbanda of Vertex Ventures. The VC has backed Kissht, an instant credit application that was also briefly banned by the government.

“If you read extensively about what the regulator has said, you will understand that there’s a very clear customer protection and money-laundering KYC (know your customer) mindset. I have no problem with regulation, if we are investing in fintech, we are doing so with a view that there will be a regulatory framework to operate within. Companies that have struggled due to regulation is because they have tried to play too cute with the regulators,” he added.