Venture Debt Sustains Startups In Crisis With Runway Support, Growth Fuel

As the world of venture capital funding takes a big pause due to the uncertainty from the Covid-19 slowdown and economic crisis, startups would be looking beyond the VC ecosystem.

While many experts have said that VC and institutional investors will prioritise investments in their existing portfolio and reduce new deal exploration activities, startups have not run out of options for fundraising.

According to 3one4 Capital founding partner Siddarth Pai, the public market has a direct relationship with the startup ecosystem, as a result of which the source of funding for all startups and venture capitals (VC) is affected. In such a situation, startups have to look at options such as large family offices, angel investors, corporate venture funds, who may not have invested in the public market.

When we look at debt versus equity in terms of funding, the returns for investors are substantially lower compared to equity, but it also is a guaranteed return and interest. Therefore, one of the things people like about venture debt is the predictability, where a venture capital firm focuses on earning quarterly returns and passing it on to its limited partners. A typical venture debt investor delivers 16-18% internal rate of returns (IRRs) QoQ. This can be recycled within the portfolio companies.

Throwing light on the venture debt model, GV Ravishankar, managing director at Sequoia Capital India said that in case the startup goes into becoming something big then the IRRs for having taken that extra risk makes up for the investment. Ravishankar added that the venture debt is available mostly to companies that have venture capital investments with some kind of comfort coming from the debt funding. “Venture capital funds will continue to support startups,” he added.

Are Debt-Funded Startups Repaying Investors?

In the current crisis, many investors have started to tighten the purse strings and explore fewer new deals. Also, there have been a few instances where startups have had to accept funding with down valuations, or when term sheets have been pulled at the last moment. At the same time, startups that have been working in sectors where consumers have cut back on discretionary spending due to Covid-19, including hospitality, ecommerce, travel, mobility and tourism among many others have taken a massive blow, and founders are now asking for longer terms to pay back their debts, anywhere between three to six months, according to venture debt investors.

In the venture debt funds ecosystem, India has a few players with Alteria Capital, Trifecta Capital and InnoVen Capital being among the leading investors. In addition to this, there are a bunch of other venture capital firms and family offices, who do both, a mix of venture equity and debt financing. Some of the notable startups that have raised venture debt funding in the recent past include Curefit, Vogo, BigBasket, Ninjacart and Dunzo among others.

Given the situation in the market, are venture debt funds getting their money back from their portfolio startups, and how effectively are they mitigating risks from the Covid-19 pandemic.

Speaking to Inc42, Rahul Khanna, cofounder and managing partner at Trifecta Capital, who has been in the investing game since 2000, and has witnessed the global financial crisis in 2008, said that in the last few years,  there has been some kind of externalities, be it demonetisation (2016), credit crisis (2008), GST rollout (2017), political uncertainties, and more, and startups have been through some amount of external shock.

This, in a way, has allowed a few of the companies to be war resilient, and to an extent respond to such situations in a proactive manner. “Our returns are obviously a function of how these companies respond to the externalities. Surprisingly, it was really encouraging to see a lot of the founders taking tough decisions quickly during the unprecedented event such as Covid-19 pandemic,” he added.

Further, he said unlike those times where founders took more time to respond, today, that is not the case as a majority of them have been very good at managing their fixed costs. In other words, during times of uncertainty, one can not control demand or supply, and capital is also an externality. So what one can do is manage the cost-efficiently, explained Khanna.

Founded in 2016, Trifecta Capital handles close to INR 1000 Cr in credit spread across 50 companies. It manages a larger portfolio of companies across sectors, when compared to other venture debt funds in the country. Overall, the company has lent close to INR 1500 Cr till date.

Alteria Capital, on the other hand, is another player in the venture debt space, which manages INR 962 Cr of credit across 25 companies, and has completed over 40+ transactions.

The firm claims to have been in the safe spot as the majority of its companies are not directly exposed to travel, hospitality or other Covid-19 impacted sectors. “We have not adopted a portfolio-wide approach, and most of our portfolio companies are sitting on a good runway. However, for some companies we have provided principle relief which has been done in a phased manner” said Vinod Murali, cofounder and managing partner at Alteria Capital.

Hundred To Zero, Overnight!  

In an extensive Covid-19 audit conducted by Trifecta Capital across 50 portfolio companies, the firm  found that a few of their portfolio companies have quickly recalibrated their plans for the year, where the expectations for current quarter is close to ‘zero.’ These companies over the course of next twelve months will be focusing on building their business back to normalcy, shared Khanna.

“Obviously, there are a few exceptions, where companies like BigBasket, Vedantu, Curefit went through an inverse reaction, where their revenue shot up and their net demand increased, dramatically,” Khanna. said

It has to be noted that the above-mentioned companies represent only a smaller percentage of their portfolio. However, a large percentage of Trifecta’s portfolio is still dealing with the lockdown and has witnessed revenue go from 100 to zero overnight.

“As a venture debt provider, we decided to be able to support them with a lot of flexibility of repayments for those startups,” said Khanna.

To tackle the revenue gap, Trifecta Capital has come up with a new framework which offers flexibility on principal repayments, where the firm has offered 30 to 90 days relaxation in the form of moratorium. “This has been taken on the basis of quarter-by-quarter or half year-by-year as a measure to see how things will unfold in the coming months,” shared Khanna.

As far as the returns are concerned, Khanna clarified that the firm will not be impacted as it gets income based on the interest (16-18%) from most of its portfolio companies, and are well capitalised. “As long as interest-income continues to be serviced, returns should not be a problem,” said Khanna, “hopefully, some of these businesses should put us back to where we were twelve months ago.”

“We are not worried about returns at this point in time. However, we are anxious about how these startups will start to adapt to the present-Covid business model as compared to post-Covid reality,” Khanna said.

According to several industry experts, the behavioural shift such as social distancing, smaller budget on consumption, and people being more mindful of large ticket spends would slowly change the business models of a lot of startups in the coming days. “Since we get to see data across such a large portfolio, we will be able to share some insights across the portfolio,” said Khanna.

A new economy is getting built around digital consumer services and companies solving big problems in the post-Covid reality will create a lot of value for their investors in the coming days. Venture capitalists that are offering venture debt funds believe in quality over quantity. At the end of the day, the portfolio construction matters, diversification matters, ticket size matters and deal structuring matters, said Khanna.

Alteria’s Murali also said that there will be a massive spike in quality, and good companies will continue to get capital and create more opportunities. “In fact, there will be larger rounds, across all forms and shapes, be it venture debt or equity,” Murali added.

Most importantly, one needs to recognise that within the venture capital or venture debt world, there are a lot of players that are more mature, seasoned and new players, and only time can tell as to who will emerge as the leader of the pack. For startups, who have working capital issues, non-equity channels will be the go-to option for solving problems, so it becomes critical for companies to manage their costs and make themselves available for the venture debt opportunity.