Debt venture funding is becoming an important component of the overall change in India, experts feel. Although debt funding as a product tends to lag venture capital by 10-15 years in all markets, it is fast becoming an option for startups to get additional funding and cash flow runway without diluting much equity.

For those who already don’t know, venture debt is a form of specialty debt financing provided to companies that are not serviced by traditional lenders such as banks. The financing is usually structured as a combination of a loan and limited equity investment rights (warrants). Companies in the technology, consumer or healthcare domain, that typically do not possess any hard assets or collateral that can be used to get a traditional term or working capital loan, opt for venture debt funding.

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“While established businesses have many options for debt financing, new economy business have only had access to equity financing to fund their growth. We are here to change that,” says Rahul Khanna, Partner at Trifecta Capital, an India-focussed US$79 million debt venture fund. “Debt funding means you dilute less, and alternatively take a little bit more money,” he adds.

Debt funding makes sense for VCs

Debt fund makes a lot of sense from a VC investor’s perspectives too. “It is in their (VCs) interest for their portfolio company to have the lowest cost of capital. Debt money is less expensive than equity. They also benefit from the fact that these companies get additional runway, and when the company goes out to raise additional (capital) later, everybody benefits from the vacation lift. So generally, it is a win-win type of a scenario,” explains Khanna.

Trifecta offers funding in the range of US$800,000 to US$4 million each to startups for a term of one to three years in return of a lower equity.

According to Sandeep Murthy, Co-founder of VC firm Lightbox Partners, venture debt is a real option with real assets where one can collateralise. “Traditional businesses always go after debt funding as they want to own 100 per cent of their company, whereas new businesses go after VC money, diluting huge equity. But VCs are always worried about the company’s capital structure, revenue growth, etc. because they believe in great returns, whereas debt funding enables companies to borrow money diluting less equity or without diluting at all,” Murthy says.

The state of venture debt in India

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There are not many venture debt companies in India. Apart from Trifecta, InnoVen Capital (a subsidiary of Singapore-based Temasek Holdings) is another debt venture fund in India. While InnoVen has already backed a number of companies, including Practo, Myntra, Capillary Technologies, FirstCry, Freecharge and Faaso’s, Trifecta is yet to make its first investment.

According to InnoVen, venture debt is the next logical layer of risk capital which provides entrepreneurs an extension of their cash flow runway between equity rounds, enabling them to make their companies more valuable with a relatively inexpensive form of capital (compared to equity). This is a form of flexible capital which works in tandem with entrepreneurs and investors to help improve the ability of the company to increase enterprise value.

“This is also a way to connect (the) old economy to the new one. For domestic investors that have legacy businesses, large institutions and brands (banks, insurance companies, development finance organisation, etc.) — who are not able to understand the new economy and don’t have the risk appetite to invest in venture capital — this is a good platform to invest their money. They have deep pockets but are not able to fully appreciate the risk profile of venture capital. Given that venture debt is seen as a lower risk and more predictable type of return models, these large guys are investing into these funds,” shares Khanna.

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According to Supam Maheshwari, Co-founder of Firstcry, debt funding helps companies to have more cash in the bank without diluting much. “It is a lower cost of capital. Secondly, when you have more money in the bank, your negotiating power is higher and increases your runway and confidence to drive your engine faster.”

Khanna adds that Trifecta will make its first close sometime soon, and will start making investments once this announcement is made. Originally proposed as a US$50 million fund, Trifecta extended its target to US$79 million given the huge demand from the market.

Venture debt relies on the understanding of venture capital ecosystem, says Khanna. “If you don’t understand the equity businesses, you cannot understand this. Trifecta is a platform for providing structured financing to the new economy, and our first product is venture debt. As the market evolves, we will do acquisition financing, pre-IPO financing, etc.,” he concludes.