Venture debt or venture lending is an alternate to debt financing provided by a traditional commercial bank. Venture debt is complimentary in nature to venture capital and provides for cost-effective growth capital along with providing an extension to an upcoming equity round. This helps founders in building their business as well as achieving critical milestones which can lead to a higher valuation at the time of fundraising.
As compared to equity financing, venture debt has a few significant advantages. For startups at a crucial stage in their entrepreneurial journey, debt can prove to be a key financing option to foster growth with a rather minimal equity dilution. The average cost of debt is also much cheaper than that of equity capital, therefore, making it a more attractive option for startups.
Venture Debt in the startup lifecycle
To help understand the journey of an entrepreneur from idea to enterprise, let’s look at the following:
A startup is much more likely to fail in its inception stage. It is said that on an average 8 out of 10 startups would cease to exist while raising their first round of seed capital or even before. This period of time in a startups life is known as the 'Valley of Death'. After overcoming the challenges faced here, the startup moves on to explore more structured forms of funding options such as institutional venture capital before finally going public. In most cases, a non-bank lender, i.e. a debt fund in this case, will offer loans to startups that have received their first round of venture capital at the very least, as part of their investment strategy to ensure a lower Non-Performing Assets (NPAs) along with a steady income in the form of interest.
Venture Debt in India
Venture debt was introduced in India 15 years ago. However, it has gained traction in the last decade. In these years, the Indian debt market for startups has been dominated by the likes of funds such as Alteria capital, Innoven capital and Trifecta capital. These firms combined have deployed approximately $300 mn (INR 2,200 crores) in startups such as Bigbasket, Curefit, Ninjacart, Dunzo and Lendingcart to name a few. In the last 6 years itself, approximately $4 bn of debt has been deployed across 150+ deals in India.
An umpteen number of funds are setting up their practices owing to the growing demand for debt in the Indian market today. Mumbai based Ivycap Ventures is in the process of closing its primary debt fund. There is a belief that a gap of about $600 million currently exists in the market which needs to be bridged. Additionally, other venture capital funds such as Ankur Capital and Unicorn India Ventures have their eyes set on creating debt funds to help Indian startups fulfil their working capital needs.
On the other hand, scheduled commercial banks such as Bank of Baroda and the Indian Bank are also eyeing the Indian startup ecosystem. Bank of Baroda has a dedicated startup scheme while the Indian Bank recently announced that it plans to set aside INR 100 crore – INR 200 crore for the purpose of startup lending in the form of debt.
However, with a funding boom in the ecosystem in the last 3-5 years and with the current availability of a significant amount of dry powder leftover, there is a venture capital slowdown expected in the ecosystem. Considering that debt financing compliments equity financing, it would be interesting to see capital deployment by venture capital funds and in turn, the strategy followed by debt funds.