Venture Debt - Fresh Deal Empowering Startup Founders

Om, an eCommerce startup owner(Startups&Knowledge eCommerce) had received his Series A funding two years back. He was now looking for working capital to meet his operational expenses, however he was not very comfortable in diluting equity base. Approaching VCs and other equity investors, hence was not in his plan. 

As he was contemplating on this issue, he came across news regarding BigBasket, the online food and grocery store raising ₹100 crore in venture debt from Trifecta Capital this year in July in order  to meet working capital and capex needs. BigBasket plans to use these funds to set up new warehouses and scale up the supply chain of its recently launched milk subscription business.

Om was excited. He decided to check out the venture debt route. 

Startup founders in the country are increasingly opting for venture debt to finance their startups, especially if they are mid stage.

The greatest USP being that they do not have to sell a part of their stakes to equity investors. Companies such as InnoVen Capital, Trifecta Capital, and Unicorn India are gaining popularity as attractive alternatives to equity investors and VC funds like Softbank, Sequoia Capital, Accel Partners, and Nexus Venture, which are the big players in the startup funding ecosystem. Undoubtedly, a viable proposition for select early-stage and growth-stage “VC-backed” companies!

Over the past few years, many startups including BigBasket, Swiggy, Snapdeal, Shopclues, Faasos, Portea, Freecharge, Practo, and OYO, amongst others, have taken this route.

Founder’s Choice 

Venture debt is an attractive financing option available today for startup promoters as it provides an alternate access to funds for their working capital, capex requirements such as purchasing equipment and even M&A activity, without diluting equity. By extending cash runway, it gives the much needed cushion of extra time and flexibility to achieve key milestones, scale up and grow before raising a new round of equity funding. 

Founders today hold very little in their startups after consecutive bouts of equity funding. For instance, during acquisition of Flipkart by US-based Walmart in May last year, the founders of India’s most-funded eCommerce venture, owned minuscule in the company. 

Venture debt presents a novel approach for startup owners to push equity fundraise. Founders become free to raise equity on own terms with cash in the bank! 

Moreover, it can also be leveraged to raise funds at higher valuations with less dilution for the same amount of capital raised, in the next equity round. Higher valuations can also be useful during a possible sale or IPO.

While VC investments mandate losing stakes of company to investors, debt funding is a loan that does not necessitate equity dilution and keeps the capital structure intact. However, it is not a replacement to equity funding.

It typically complements equity funding and is structured as a three-year term loan with warrants or rights to purchase equity (options), to compensate for higher risk of default. This mode reduces cost of capital and can be cheaper as compared to loans from NBFCs depending on the stage of the company. 

Who gets Debt? 

The market for venture debt transactions is directly proportional to that of the VC industry.

Venture debt funds piggyback on the due diligence done by VCs. In order to mitigate risks, these funds lend primarily to VC backed startups and companies in their growth stage, that are comfortable to raise the next round of equity funding, thereby reducing the possibility of NPAs.

Many entrepreneurs turned investors today prefer debt to park capital as a safe risk management strategy. 

Needless to say, revenue based startups are lucrative bets eligible for venture debt. 

Rising Market

Venture debt funding started in US in the 80s and gained prominence over the years when companies such as Facebook and YouTube opted for it. 

The growing availability of venture debt as a strong asset class in India is a huge relief for startups that are often not considered creditworthy by banks due to lack of collateral or profitability. These startups may also not be willing to raise funds against equity at an early stage when their valuations are low.

With prominent VCs having established initial portfolios, the role of venture debt become even more relevant to fill the coffers, as VCs get more inclined towards fewer, higher quality deals of bigger size for these portfolios. 

Moreover, there is more liquidity in the market with exits like Flipkart. As a consequence, many entrepreneurs are now investing in startups, and they are more inclined towards hybrid models of venture debt. Two -wheeler rental startup Bounce which raised more than $90 million in equity, also received $3 million in debt across two rounds over the last six months. It is currently in talks with BAC(set up by Sachin Bansal, co-founder of Flipkart) to raise a third round of debt funding, as Bounce uses debt to finance purchase of scooters, its main asset. 

Quikr, an online classifieds company, raised ₹55 crore in venture debt funding from InnoVen Capital, to scale its businesses. A few days later, Moglix, an online store for industrial tools and equipment, raised ₹142 crore from VCs including Accel, Jungle Ventures, and International Finance Corporation (IFC), besides venture debt firm InnoVen Capital, among others. In July, Mumbai-based executive education service provider Eruditus Executive Education raised venture debt of ₹16 crore from InnoVen Capital. Bengaluru based hyperlocal logistics app, Dunzo Digital secured $2.04 million in August this year from Alteria Capital. LightBox’s portfolio company Furlenco, a furniture rental startup, also raised several venture debt funds in the past year.

Interestingly, even unicorns are keen on venture debt.

InnoVen, for example, extended venture debt to many unicorns this year, including Swiggy, OYO and Quikr.

Furthermore, velocity of follow-on deals is becoming high as startups begin to raise a debt component along with equity funding. The country’s notable venture debt providers - Temasek-owned InnoVen Capital and Alteria Capital have completed follow-on rounds in many companies this year. While InnoVen has reinvested in two-wheeler rental startup Bounce, logistics firm Xpressbees and agri-tech firm Agrostar, Alteria did follow-on rounds in learning startup Toppr and Bounce rival Vogo. 

No doubt, there has been an upsurge in the past year.  

Are Indian startups well positioned to attract venture debt investments in future as well? 

Will venture debt deals and providers boom this year? 

 Future Trends 

With the Indian startup ecosystem maturing and getting competitive, venture debt is a lucrative bet for startups today. 

The market is likely to grow with increasing demand from startups, more players in the space and greater awareness about these financial offerings. As new business models evolve in the coming years, venture debt would be instrumental in supporting startups.

Debt funding is going to play a vital role in journey of startups. 

Now, Om is on his way to apply for venture debt. 

Can venture debt improve startup efficiency? 

Can venture debt accelerate success rate of startups in the country? 

Startup Noodles, Spice ‘em Up