The reason the market for venture debt is booming

Venture debt issued in India almost doubled from $271 million the year 2019 and reached $538 millions by 2021. Experts suggest that the slowing down of equity markets is the primary factor in the rise in demand. The momentum isn’t likely to slow down.

As the macroeconomic outlook deteriorates as investment in venture capital (VC) investors slow down their process of writing cheques startups are turning to venture lenders that provide the financing for debt. “Earlier we would have to close one deal out of 10. We are now evaluating between 20 and 30 companies prior to concluding a deal,” states Apoorva Sharma from Stride Ventures, one of the top six venture capitalists on the Indian market. In the past year, this New Delhi-based firm made use of an amount of Rs1,100 million (approximately $134 million) over the course of 60 transactions. In the current year, the total is already at Rs1,300 million ($159 million) until September.

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In actuality the amount of debt repaid via Venture debts in India increased by a third in 2021, reaching $538 million rising from $271 million in the year prior according to Stride Ventures’ India Venture Debt Report 2022. One-hundred-and-eleven companies raised venture debt, including Mensa Brands, Urban Company, and Licious, with ticket sizes ranging from $2 million to $25 million.

Based on Venture Intelligence, a data service that tracks data, the initial six months in 2022 seen startups receive 289 million dollars in venture debt financing. However, this is “quite low” in the words of Ashish Sharma the managing partner at Innoven Capital, as several deals are not reported. He is of the opinion that in this year there will be a significant amount venture capital being poured into Indian companies, specifically ones in late stage or growth may exceed $1 billion.

“Deal flow is extremely busy,” he says. The decline in market for equity is the main reason behind the increasing demand. Startups aren’t getting the same amount of capital like they used to and even if they do being funded, they’re not achieving the ideal valuations. This is particularly true for early-stage and growth startups. Consider the example of MobiKwik. The online payment provider acquired the sum of Rs35 crore as capital via BlackSoil in August. This was despite an indefinite delay to its initial public listing (IPO). It was over a year after it had filed the Draft Red Herring Prospectus with the Securities and Exchange Board of India (Sebi).

Public market valuations that are inflated as well as less-than-conducive IPO markets, and investor pullback have resulted in startups using debt to finance their business in order to not dilute their equity while still achieving their business goals, according to Innoven’s Sharma.

“Venture debt is helping give a runway to entrepreneurs with cash shortages until situations improve.” states Sanjay Mehta, the founder of 100X.VC which is a funder for early-stage startups. Then, they can raise funds with a better foundation and at higher valuations.

Although the market for venture loans is currently booming however, it has actually seen an increase in the past three or four years. This is due to a variety of than just structural factors.

One is that the ecosystem is maturing and the founders are more knowledgeable. “Education of founders increased by a large amount,” says Ankur Bansal of BlackSoil. They are now more aware of the intricacies regarding debt, and the ways it can assist in achieving their goals and plans, he says. The benefits of venture debt are not limited to extending the potential of a new business in the uncertain funding climate, but also to assist it in meeting its the requirements for working capital as well as supply chain requirements or to fund deals and mergers. “Often when equity financing is exhausted, larger players utilize it as an opportunity to acquire smaller companies. Venture debt is an excellent alternative, rather than use equity to reduce the stake you hold,” says Stride’s Sharma. For instance, last year was a huge year for Thrasio-style companies such as Mensa, Global Bees and Upscalio. “Acquisition was an essential part of their business model and borrowing money made sense,” she says. In the same way, D2C beauty brand MyGlamm acquired a hefty amount of capital via Trifecta Capital and Stride Ventures to fund a number transactions in the social and content media industry.

In addition, the amount of money available has grown. The traditional venture capital financing has grown from $13 billion in the year 2019 to $35 billion in 2021 as per Venture Intelligence. “Venture credit is considered a derivative asset type that is, in essence, it follows the funding of venture capital,” says Innoven’s Sharma. “So as the market for venture capital has grown the market for venture debt has also increased. It’s just a natural development.”

Thirdly, the availability of venture loans has grown by a significant amount of money flowing to businesses. The venture debt funds of India generated $85 million in FY21, an increase from the $62 million during FY20 as per Venture Intelligence. Stride For instance, the company announced the close to its flagship second fund, which was 200 million (Rs1,600 million) at the end of August far exceeding the amount of money it was aiming for. The lender noted that it has received participation from major banks as well as marquee family offices, corporate Treasurys, sovereign funds, Private equity fund, insurance companies and HNIs, and without listing the LPs (limited partnership). Tickets are scheduled to increase between $2 and $3 million with the initial fund and increase up to $4-$5 millions (Rs30 crore to Rs 40 crore) in this fund.

“Over the past three years, I’ve witnessed an increase in interest from investors in the US. In the past, it was thought to be a exclusive. Today, we’re seeing family offices, and even founders who have liquid funds pumping money into venture debt” Innoven’s Sharma.

Despite the increased demand, financers of venture debt are cautiously optimistic. “It’s not when a business does not raise venture equity that it is able to borrow the capital needed to finance ventures,” Bansal says. Bansal. “The inspection is strict and so is the focus on the unit cost of economics.”

Stride’s Sharma is also aware that monitoring and due diligence levels actually been increasing. “Our conversion ratios are smaller now. We’re taking longer to determine the companies we’d like to invest in,” she says, noting that the basic criteria include the minimum requirement of $4 million equity capital from the startup and at minimum Rs2 crore in monthly earnings in unit-economics that are positive.

Despite its rapid growth however, venture debt is only a tiny portion of the market overall. “India’s sector of venture capital is extremely under-penetrated. It’s less than 2 percent of venture capital flows annually as compared up to 15% in US,” says Stride’s Sharma. The potential to expand is huge and the pace of growth isn’t going to slow. According to the CEO of Innoven, Sharma, “There’s no turning around from here. We’re going to be on an adventure.”

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