If you follow the start-up space, it is hard to miss the talk about the slowdown in the funding frenzy. Even the big guys like Tiger Global aren’t bringing their cheque book out in a hurry to support their portfolio companies in follow-up rounds if they aren’t scaling up to expectation.
While this will bring some sanity back to start-up valuations, for start-ups who have gone through Series A funding, not getting the much needed follow-on funding will likely threaten their existence. For start-ups that chose to throw financial discipline out of the window, consolidation and shuttering down will become the norm in the coming months. But for start-ups who did most things right and are probably a little ahead of the market, could venture debt emerge as an alternative to another round of equity infusion?
Venture debt is a relatively new phenomenon in India, but it is finally here. According to Rahul Khanna, managing director, Trifecta Capital, venture debt usually becomes a mainstream option a decade after the venture capital ecosystem develops. With a targeted corpus of ₹500 crore, Trifecta – India’s first independent venture debt fund – has raised ₹200 crore so far. It has lent ₹36 crore to three start-ups so far – the Hyderabad-based dialysis chain NephroPlus; logistics firm Rivigo and messaging platform HelpChat.
So, how does venture debt work? They usually follow after an institutional equity round has been raised, be it Series A, B or C. In the case of NephroPlus, the firm raised $14.2 million from Bessemer Venture Partners and IFC; Rivigo raised about $10 million from SAIF Partners and HelpChat snapped up $16 million from Sequoia Capital.
The debt is priced around 15-17% and debentures are secured with collateral like IP or brands. The loan is usually to be paid back within two to three years. And the lender has the option to invest 10% of the loan value in equity. While this is not included in the loan amount, it acts as an additional kicker to the venture debt return. In the case of Trifecta, the loan amount is capped at 20% of the most recent round of equity funding. On average, they are looking to invest about ₹5-20 crore in about three to four firms every quarter.
Apart from Trifecta, InnoVen Capital is the other player of consequence in venture debt in India. When Temasek acquired the India business of Silicon Valley Bank, which pioneered venture debt in the US, it was rechristened InnoVen Capital. The firm which functions as an NBFC has financed more than 50 companies since it started operations in 2008.
Not all start-ups make the cut for venture debt. Cash guzzlers are unlikely candidates. Trifecta which has RBL Bank as its anchor investor plans to stick to healthcare, consumer and technology firms. Also, if you don’t have an institutional investor on board, then you are unlikely to get venture debt. After all, venture debt provides capital to get to the next milestone so that valuation bumps up by the next round of fund raising.
From the entrepreneur’s perspective, venture debt makes sense because he can avoid unnecessary dilution and the cost of debt is less than cost of equity. Now, the real question is will venture funds really step up and support start-ups when the equity market is somber? Given that they don't have the same risk appetite as equity investors; will they really be willing to take bold calls?