In 2018, when Vaibhav Khandelwal, founder of B2B logistics startup Shadowfax, wanted to expand operations in new markets, he raised an undisclosed sum of money in debt from venture debt firm Innoven Capital.
“When you look at the capital structure of a company, a lot of them take debt. That’s because in their capital structure they want both equity and debt,” Khandelwal said.
Although, traditionally, almost all businesses have grown on the back of debt provided by banks and NBFCs in lieu of a collateral, tech startups have mostly been shy of raising venture debt.
Lack of knowledge about it is one reason why venture debt took so much time to take-off in India.
Avishek Gupta, partner at Hyderabad-based fund Caspian Capital, added that debt as a product was never available to technology startups. “If you look at debt, traditionally, banks or NBFCs would provide debt, but they would need collateral since investing in startups is high risk for them. Since most tech companies are built on an asset-lite model, with no collateral to offer, there were hardly any debt providers,” Gupta said.
This began to change in 2009 when Silicon Valley Bank (SVB) set up shop in India. SVB was bought by Singapore-based fund Temasek in 2015, which rechristened it as Innoven Capital, a dedicated debt lender to Indian startups.
“In its SVB avatar, Innoven was the first venture debt platform. There was a lot of education in the market then, but it was not deep enough,” said Ashish Sharma, partner at Innoven Capital.
“In the last five to seven years, as more and more companies have started using venture debt, both founders as well as the investor community have become aware,” Sharma added.
Out of the hundreds of venture capital funds that offer equity funding — lending money in return of company shares — there are only five to six funds in India that provide debt. Funds such as Innoven Capital, Alteria Capital, Trifecta Capital, BlackSoil Capital and Caspian Venture Capital are well-known debt providers in India.
To be sure, Caspian Venture Capital offers both equity as well as debt fund to startups and doesn’t limit itself to back only technology companies.
Sharma said entrepreneurs should look at raising debt because the cost of equity is very high. “If you fund your whole business through equity, your return on equity when you start making profits will obviously not be very high. Basically it’s like financial management, all other big companies, including very profitable ones, take debt to optimise the capital structure,” Sharma said.
Rise in debt
The rising interest in venture debt in India, according to Sharma, follows the growth curve of Silicon Valley.
“In the US, venture debt is 20% of venture capital. Two years ago, venture debt was just 5% of venture capital. There is so much headroom. The fact that there is a lower risk instrument, and on an average it delivers better returns than most VC funds, it’s fabulous,” said Arpit Agarwal, principal at Blume Ventures.
Analysts say the rise in reliance on debt shows that the market is maturing, much like the Valley in the US. India leads in venture debt funding in Southeast Asia, according to various investors. Innoven Capital, which is present in China, India and Southeast Asia, has loaned money to 26 companies in China, 24 in Southeast Asia and 100 Indian startups.
“The penetration of venture debt in India is higher than what it is in China,” Sharma said. According to Agarwal, venture debt funds have worked really hard to educate the market and that is why we are seeing a rise in venture debt funding in the country.
Companies such as Snapdeal, Shadowfax, OYO, Dunzo, scooter-renting company Vogo and others have raised money via debt. Caspian Venture has invested Rs 1,300 crore as debt in about 120 companies over the six years.
Founders and investors The Passage spoke to said debt as an asset class is a win-win for both parties. While it gives better, fixed and low-risk return to investors, it provides a safety net to founders at a fixed price.
Khandelwal from Shadowfax said venture debt is really helpful for founders as it not only provides capital for a specific need, it also allows founders to retain their shares in the company.
“If you raise money only through equity, you risk losing control of your company,” Khandelwal said.
Agarwal said once a startup raises money using debt, it knows exactly what interest rate it’s paying and can build that into the cost structure to scale up.
“Venture debt can be a boon for companies that know they have to burn a lot of money initially, but can make money on operations. It’s also a good fit for companies, say in gaming, that don’t have much revenue, but they want to make sure that they continue to grow without worrying about the financials. In that case, venture debt allows you to extend your runway, which can give them more time to create a better valuation,” Agarwal explained.
Debt only for equity-backed companies
The rise in venture capital funding has directly affected the rise of venture debt, as most venture debt funds invest money only in companies that have raised at least Series A from a VC fund.
“We can only invest in companies that have at least raised some level of institutional capital. It’s generally series A round or later. In the last two to three years a lot more capital has come in, which gave confidence to venture debt providers to back these entrepreneurs,” Sharma said.
He said as companies become bigger, the willingness to do bigger investments with them also goes up, allowing debt funders to participate in a follow-on investment as well.
“In the venture debt model, we also have the concept of taking some equity kicker, so that we can participate if the company has an exit. We can also participate in a small way in the upside of the company to justify taking the credit risk,” he said.
Gupta from Caspian Capital believes one of the challenges for entrepreneurs wanting to raise debt is that it’s not available for startups that have not raised equity. He said many of the 120 companies that Caspian has backed hadn’t raised any equity money.
“The current venture debt funds would only back companies that are already backed by a selective list of equity investors. Not every company will be funded by those set of investors. So these companies can still not raise debt through the existing venture debt backers,” Gupta said.