Rising venture debt market in India: A strategic shift or a short-term frenzy?

“Last year, we saw a significant increase in all deal flows and the venture debt market was also growing. We committed about Rs 400 crore. This year, it will be higher as money (that is available with venture debt companies) for deploying is growing,” Vinod Murali, managing partner at Alteria Capital, told Moneycontrol.

How venture debt players stand

Currently, Alteria has around Rs 2,800 crore in assets under management (AUM) and a portfolio that includes at least eight unicorns, including Infra.Market, BharatPe, Cars24, and Rebel Foods. Unicorns are startups valued at $1 billion or above. Alteria is also currently raising funds for the third round.

Similarly, Trifecta Capital expects to invest 30 percent more than what it did in 2021

“This rapid increase is coming from greater founder awareness, more innovative structuring, deeper and more diverse pools of capital as well as the overall market sentiment shifting towards sustainable business growth,” said Rahul Khanna, managing partner at Trifecta Capital, which has backed the likes of Arzooo, Cars24, BigBasket, and BlackBuck.

Since the beginning of FY22, aggressive tech investors are reducing their exposure to high-growth companies and are focusing on profitable businesses with sustainable business models.

Many venture capital and private equity companies are also advising startups that need cash to survive to consider flat and down rounds, or turn to venture debt as valuations across the globe are falling.

In fact, in a conversation with Moneycontrol, Apoorva Sharma, managing partner at Stride Ventures, said revenue multiples for certain sectors have started to sober up.

“For B2B (business-to-business) Saas (Software-as-a-service) companies, the multiple on revenue had reached more than 40-45x, which has now come down back to the 10-15x,” he said.

The same has been the case for B2C (Business-to-consumer) e-commerce sector, according to Sharma. “Again a very bloated sector, multiples had reached 10-15x. It has come back to around 6x kind multiples on revenue,” she added.

Witnessing a dip in valuations, startups seem to turn towards venture debt. “Factoring the current market scenario on our underwriting and being only halfway through September, we have disbursed Rs 10 crore in one deal so far. We have two more in the execution stage amounting to Rs 20 crore,” said  Ankur Bansal, cofounder, and director, BlackSoil.

As global interest rates increased, the current value of startups’ cash flows got smaller, thus denting valuations. The publicly listed tech stocks have crashed more than 50 percent from their highs and still look to be treading water. These factors, coupled with funding uncertainty, have left many startups worried about their cash runway.

“We have underwritten three loans in this quarter with an average check size of $1 million. We are offering the continuity loans to startups that have more than $1 million in ARR (Annual Recurring Revenue) and their yardstick score is in the top quartile,” said Ravi Chachra, co-founder of 8vdX, a YCombinator-backed venture debt marketplace.

More investors shifting focus towards venture debt

In fact, several venture debt players say that many limited partners (LP), including family houses, domestic investors and high net worth individuals (HNIs), have shifted focus towards the venture debt market.

Many venture debt investors and LPs, who, traditionally, have only invested in the venture capital market, are looking to tap into this growing segment as it offers a strategic advantage.

“Over the last three years, there has been a lot of interest from the domestic pool of capital, pumping money into the venture debt market. Earlier, it used to be very niche. There has been an increase in interest from family offices, and even some founders with liquidity are keen on this asset class,” said Aashish Sharma, managing partner at Innoven Capital.

The deal flow has also increased from pockets of late-stage companies and sectors which are not akin to taking debt, said Sharma of Stride Ventures.

“This gives us the opportunity to deploy in sectors and stages of companies where we would otherwise not get the opportunity of deploying,” said Sharma. “The interest rates have increased in the market. We are able to increase our pricing by 50 basis points to 75 basis points in certain cases,” Sharma said.

Sharing similar views, BlackSoil’s Bansal also said that although nascent and evolving in size, venture debt has garnered investor attention as there is regular income, short tenure investments, and capital safety.

Venture debt players keen on I0T, SaaS

“Segments where we see high activity include electric mobility and green energy, IoT (internet-of-things), SaaS, health care, logistics, etc. These are also segments which are seeing continued VC interest as well,” said Khanna of Trifecta.
While many venture debt firms have said that they remain sector-agnostic, Crypto and Edtech are not in their foray.
“Stable business model is a key for raising venture debt and we have several filters. In fact, we haven’t done any crypto deals. We felt it was all binary in nature…we are trying to understand the other startups in the Web3 ecosystem,” Alteria’s Murali told Moneycontrol. “We will take some time and stay away from sectors where there is a lot of regulatory fuzziness,” he added.

In fact, data from Venture Intelligence reveals that around 12 deals in 2022 to date have gone into e-commerce, 10 to fintech and around six to Agritech.

“The only sector that is probably fizzled out and not doing well is Edtech because a bubble was created there and there were too many companies that came very soon. This is a general consumer behaviour that has changed. People are now back on the streets, and schools and colleges have opened after COVID,” said Stride’s Sharma.

Growing use cases and tight due diligence

Use cases which are seeing increased demand include financing inorganic growth opportunities as the environment is ripe for consolidation in several segments, said Trifecta’s Khanna.

“Financing working capital and capex are significant use cases as several companies have realised that an asset-light strategy may not be suited for all contexts,” he added.

Meanwhile, the focus on corporate governance, due diligence, and investor reporting has increased, and amidst high deal flows, venture debt players still play the field cautiously.

“Earlier we used strike 1 out of 10 deals. Now, we are assessing 20-30 companies before making a deal,” said Sharma of Stride Ventures.

“Definitely from a multiple on GMV (gross merchandise value), people have shifted to multiples on net revenue. They are also cognizant of how your bottom line looks, and how your unit economics looks. That has changed. Earlier, people were not bothered about what happens in the P&L below GMV,” she added.

Not a short-term frenzy or an equity alternative

“There is a far deeper and structural trend on the quality of businesses, knowledge, networks and acumen of founders and depth in capital markets which are happening in the Indian startup ecosystem,” said Trifecta’s Khanna.

“It is only natural that debt and other forms of financing will grow to at least 10-15 percent of equity flows as these long-term trends play out, as they have done in other markets,” he said.

Reduced FOMO (fear of missing out) sentiments among venture capital players, correcting valuations and the need for sourcing other asset classes will keep fuelling the growth of venture debt.

“Venture debt is not always a substitute for venturecapital. Venture debt and equity usually go hand-in-hand. Companies that will not be able to raise equity in the near-term may also find it hard to raise debt. The debt is basically to delay their fundraise, keep the business running and raise equity when valuations are right,” said Innoven’s Sharma.

At present, the key for most startup founders is in extending the runway to the next equity fund-raise.

“While debt levels will rise across the startup ecosystem, most founders understand this is a stop-gap arrangement and equity will be a necessity. Further, it should be noted that most startups accessing venture debt have either decent existing runways, robust business models or are market leaders,” said Ankur Bansal of Blacksoil.