The high-risk, high-reward world of venture capital is an ever-shifting place where the future of business is predicted today. Inc42’s Moneyball is series which focuses on the who’s who of the venture capital world, deconstructing the trends, how it works, the impact it has, why it works and what it feels like to be part of the world of venture funding. This week, we speak to Ajay Hattangdi, cofounder of Alteria Capital. Explore other Moneyball stories here.
Venture debt has gained favour with Indian startups in the past two years as a great source of running capital, but for Ajay Hattangdi, cofounder of venture debt firm Alteria Capital, the movement has been almost two decades in the making.
Starting the country’s first venture debt program at Citibank way back in 2005 to heading InnoVen Capital and then starting Alteria Capital in 2017, Hattangdi has a long history of tailoring business loans for risky but rapidly-growing new-age companies — a passion that not many shared in the early days.
Today Alteria’s INR 960 Cr first fund has financed more than 20 deals, the latest being an INR 35 Cr cheque to cloud kitchen operator Rebel Foods. We talk to Ajay Hattangdi to figure out what his plans are for the next year and decade. But first, he wants to remind us how far the venture debt world has come from when people used to just consider them burdensome. “I think now most founders get the value-add of venture debt. It minimises equity dilution, it helps extend a company’s runway,” he says to warm up to the topic.
As one of the pioneers of venture debt, what do you think were the challenges that venture debt faced over the years?
Ajay Hattangdi: Now I have done venture debt at a bank, an NBFC and a fund and the challenges are different at different stages. When I started in Citi Bank in 2005, the hardest thing to do was convince people that a business like this can be run sustainably, despite the fact that the companies we would lend to were “wrong” as potential borrowers. Banks don’t lend to companies which are pre-revenue or pre-profit and don’t have collateral. So it flew in the face everything a bank thinks is logical in terms of lending risk. After my stint at the Silicon Valley Bank India, the challenge was that it was still a very new market. A lot of valued firms were still setting shop in India. Their agenda was to build a thesis of what works in India. As a venture debt provider, who rely on venture capital firms, the risk in the early years was that you are lending to VCs who were themselves finding their way.
So in every other market, if you see, the venture debt comes after venture capital after about 10-15 years. And that is how long the VC industry takes to develop its investment models, work through its learning curve. As opposed to that, In India, we were coming in and riding shotgun on the car in which the venture capital industry was still learning how to drive.
What are the reasons that Indian startups have warmed up to the idea of venture debt in the past few years?
Ajay Hattangdi: So venture debt is a good useful top-up of capital to take along with equity and is less expensive than venture capital. With the perception of an economic slowdown, companies are also looking to keep some money in the bank. So while the fundamental value of venture debt has remained the same over the years, companies have now seen it in action so that itself develops a virtuous circle.
Venture capital has a much spoken about 80-20 rule. What are the odds like for venture debt?
Ajay Hattangdi: On the venture debt side the period for returns is much shorter. The loans have a 2-3 year repayment cycle. So I don’t need my company to become a large successful company before I get my investment back (unlike VC firms which have to wait for 5-6 years). So my thesis is that at the worst I make back my principal and get a return in the mid-teens in terms of percentage points. Provided that my write-off ratio is at 1-2%. As long as that is taken care of I can make a very good return for my investors. And if I get an exit on the equity of some of my portfolio companies, that spikes my returns to above 20%
What is venture debt structured like?
Ajay Hattangdi: Typically we lend about 20-30% of the venture capital coming into the company. The loan period will be two-three years. The interest rates on these loans tend to be in the mid-teens. And then we get an equity kicker for about 10-15% of the loan amount. However, that is open-ended and can come in 7-8 years
What do you look for in a startup in terms of stage, brand recognition, maturity?
Ajay Hattangdi: Our target market are VC-backed companies which need some money for building products, marketing etc. So the fundamental thing we look for is who is the VC, how the founding team looks and what is the business plan. And then we assess the company’s ability to raise further capital.
The reason we don’t look at companies which are bootstrapped or not-VC funded is that debt can help a company leverage its equity and prevent dilution of shareholding. However, on the other side debt has repayment obligations. So when a startup is doing well, all of the benefits of venture debt are available to it. But when a startup goes sideways for a few quarters, the loan repayment does not stop. So, therefore, the sensible thing to do in our opinion is to raise debt only when two things happen: One it has the business cash flows to support a down turn, or when the cushion of capital is not provided by business flows but by equity investors.
One more reason is that as lenders we do not take board seats on our companies. So we have no eyes and ears on the ground. With a VC in a deal, those things are taken care of.
The value of venture debt is often described in a number of ways — the phrases “bonus round” and “insurance policy” are common. Do you think this is true?
Ajay Hattangdi: Fundamentally what venture debt does is that it gives a company more time to continue its growth pattern. Ultimately what valuations depend on is what business traction the company achieves.
For example, a startup raises INR 30 Cr. And it burns INR 2 Cr a month. So that gives it 15 months of life. Now to raise the next round it has to achieve certain goals. All of these things need to be done before the 15 months. But these things don’t behave according to an excel spreadsheet. So the last thing you will want as a founder is to go into the next funding round before your valuation milestones have been hit. So what venture debt does is that on top of that INR 30 Cr, the company has INR 6 Cr of debt. And this can give the company another three months of life. So it buys them time to hit their targets. And that is why it is called an insurance policy. And as insurance policies go, they are available when you are healthy but not when you are on your way to the hospital.
Your portfolio is heavily focussed on millennial-centric companies like Stanza Living, Dunzo, Vogo and Rebel Foods. Is there a specific focus for Alteria here?
Ajay Hattangdi: No, we are sector and stage agnostic. The starting point for our business is when a company raises venture capital. So our portfolio will always be a derivative of what venture capital portfolios look like. But there is a caveat to that. When a company comes to us for a loan, we look at its ability to raise further capital. For that it means we have to take that call on if this is the business model that VCs would like to invest in 12-15 months down the road.
So while a VC might put in money into a company so as to take a chance with a new sector, that does not mean they will follow up in the next round. So that’s the other thing we need to look at — that whether the VC-backed company is in a sustainable sector or is it a FOMO (Fear Of Missing Out) investment by the VC which will not see the light of the next funding round.