The Covid-19-forced lockdown and the resultant sluggishness in the economy have spurred startup entrepreneurs to fortify their capital structure and streamline finances. With equity funding becoming dearer, venture debt is becoming the go-to option.
“Between March and May, some 180 startups approached us for funding – and a good number of them are companies in growth stage,” said Ishpreet Singh Gandhi, founder of Stride Ventures, a venture debt asset manager.
Most venture debt fund managers have witnessed “a tidal wave of funding requests” in the past two months. Stride closed four deals during the lockdown, while peers Alteria and Trifecta claim to have concluded four to six deals between March and May.
“Many of these companies are trying to raise debt because they do not foresee possibilities of an equity fund-raising in the immediate future. These companies are also not able to raise loans from banks or NBFCs. Traditional lenders do not usually lend to companies that are not profitable at an operating level,” Gandhi explained.
Venture debt is a form of debt financing for venture equity-backed companies that lack the assets or cashflow for traditional debt financing. By borrowing money, the startup entrepreneur escapes further dilution of equity in the company. In 2019, as per Venture Intelligence data, these funds booked 67 deals worth $207 million. Between January and May this year, venture debt funds disbursed $56 million across 21 deals.
“We’re quite cautious in our approach. Nobody knows what the unknown risks are,” said Rahul Khanna, MD of Trifecta Capital, which disbursed Rs 1,500 crore to 60 companies in the past three years. “As debt fund managers, we face credit and recovery risk. So, we’re looking at companies that will do well once the situation normalises a bit – in six to eight months.”
By no means is this cheap money because the bets involved are risky. The borrowers are mostly startups with limited cash flows and no profit. The rates range from 14% to 17% per annum for 24 to 36 months. There are funds that offer shorter-tenure loans as well – a bridge loan for eight to 10 months – charging 18%-24% as interest. Nonbanking financial companies, too, charge similar rates for poorer credit quality, while for short-tenure loans such as overdrafts or card money, banks charge 28%-36%.
Startups with a low capital base (with adequate funding for 6-8 months) are generally not offered financial assistance. The ones seeking short-tenure bridge loans are also not entertained by larger players as there is not much money to be made for the fund.
“Founders are now more conscious of their need for capital,” said Vinod Murali, managing partner at Alteria Capital, which has concluded about 45 deals worth Rs 900 crore since 2018. “Covid-19 and the lockdown have dampened the growth plans of several startups. Many are forced to reset their targets now. The funding ‘runway’ has also shortened for several companies, forcing them to shore up more capital.”
In startup parlance, ‘runway’ refers to the time a company has before it runs out of cash.
According to Murali, even well-established startups are now raising debt to create additional capital buffers. Businesses in spheres such as ed-tech, gaming, B-to-B marketplaces, intra-city logistics, health-tech, logistics, dairy-tech and agri-tech are finding it relatively easy to raise debt funding.
“Venture debt, as an asset class, is relatively younger than venture equity… That apart, as startups grow older, their capacity to absorb debt also goes up. So, we’re seeing a lot of established startups raising debt rounds now,” said Trifecta’s Khanna.
“We were lucky to raise some debt capital in December… By then, there were clear signs of a global slowdown. That’s when we decided to beef up our capital base to weather the upcoming storm,” said Nikhil Sikri, founder of Zolostays, a co-living brand that raised money from Trifecta.
Many a time, venture debt funds are structured in a way to allow the lender minor equity participation. The equity kicker is usually 1%-2% of the money loaned. An equity kicker is an option to participate in future profits of the firm, exercisable for a specific period – either the life of the fund or the loan tenure.
“Debt funding will go up in the coming months… There’s a lot of dry powder (referring to money) waiting to be deployed. As a fund, we expect to do Rs 600-700 crore worth of deals over the next 12 months,” said Murali of Alteria.