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While private equity investments and initial public offerings are in vogue, many Indian startups are also increasingly raising debt to fund their operations.
According to data accessed by BusinessLine from Tracxn, conventional debt has seen a 5-year CAGR of 40.27 per cent till 2020 while venture debt grew by 21.86 per cent.
Venture debt investments ballooned in 2019, though 2020 was comparatively dull due to the pandemic. Around $4,384.43 million was raised through conventional debt across 131 rounds, an increase of over 260 percent as compared to $1215.38 million raised in 2018 across 111 rounds. For venture debt, this figure stood at $144.89 million in 2019 across 47 rounds, growing 63.7 per cent from $85.51 million raised over 38 rounds in 2018. In 2021, year-to-date, the numbers have been equally promising. Conventional debt so far accounted for $2554.58 million across 64 rounds and venture debt stood at $88.15 across 25 rounds.
“The asset class (venture debt) has seen a useful convergence of higher awareness among founders, need for more cash buffer due to Covid, a better understanding of the use cases of debt and finally, increased availability of debt capital. As an illustration, Alteria has funded more than $90 million of debt across over 20 companies in the first six months of 2021 which used to be the entire market size just a few years ago,” Vinod Murali, managing partner, Alteria Capital told BusinessLine.
Devendra Agrawal, founder and CEO, Dexter Capital Advisors said , “In India, venture debt is a comparatively new segment. We are still at least 20-30 years behind as compared to markets like the UK. Venture debt is becoming popular among start-up founders as they don’t have to dilute their stake. Also, it is more certain and quicker to raise funding from a venture debt fund than a venture capital fund. Venture capital firms are more stringent with diligence and checking track records of the start-ups as compared to venture debt firms, who know they will end up making at least 15 per cent in return.”
“In terms of size, venture debt is still way smaller than the share of equity funding. Right now, it is less than 5 per cent and I would like to believe it will eventually grow to become 25 per cent of the size of equity funding as an asset class, where it will stabilise,” Agrawal added.
Top sectors
As per Tracxn, the top five sectors that opted for venture debt in the five-year period starting from 2016 include the consumer sector which accounted for 119 rounds of funding, retail with 75 rounds; transportation and logistics tech with 33 rounds, food and agriculture technology with 31 rounds, and fintech with 21 rounds respectively.
“There are some sectors which need a relatively higher level of leverage such as the Thrasio model where apart from identification of good brands and strong execution, the business model needs the right mix of leverage and equity. In the same way, there are several credit engines within B2B models as well as broader financial services which need venture debt to allow for proof points and basic illustration of their business model. These have recently become strong use cases for venture debt. Other interesting sectors include edtech, healthcare, agritech, SaaS and consumer companies,” Murali said.
Advantages of venture debt
Most of these deals happen at interest rates starting from 12-13 per cent and going up to 18 per cent for a period of one to three years depending on the size, plans and track record of the start-ups.
“Often an early-stage start-up would opt for debt to extend their cash runway and ensure that the next round of equity funding happens at a higher valuation. Even a $100-million start-up would be looking at venture debt as an option to access faster working capital to scale and expand into other verticals. They don’t want to do it using equity money as it is very expensive,” Ankur Bansal, co-founder and director, BlackSoil Capital told BusinessLine.
Bansal added, “Usually, we think a 15-18 per cent interest on debt is so high, but equity is much more expensive. They don’t come at a 15 per cent interest rate of return; the investors are coming for an IRR of 30-40 per cent even for an early-stage start-up. That’s the kind of return they are looking for, and in a 5-8 year period this can amount to a lot.”
Moreover, depending on the business models, start-ups tend to opt for a mix of equity funding and venture debt. Often money raised through venture debt is used as a buffer to keep the business running and growing between two rounds of equity funding.
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