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From Credit Guarantee To Dedicated Bank Branches: Can Debt Funding Solve Startups’ Woes?

From Credit Guarantee To Dedicated Bank Branches: Can Debt Funding Solve Startups’ Woes?
SUMMARY

The central government’s credit guarantee scheme for startups is expected to improve access to bank credit

Startup-focussed bank branches will be better equipped to study product-market fit and technology risks of new-age businesses

UHNI and HNI investors from India’s Tier 3 and 4 cities are also keen to explore startup opportunities

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The central government recently notified the Credit Guarantee Scheme for Startups (CGSS). The scheme would provide guarantees for loans extended to new-age businesses by banks, NBFCs and venture debt funds registered under alternate investment funds (AIFs) with the Securities and Exchange Board of India.

Nearly a month before this announcement by the Department for Promotion of Industry and Internal Trade (DPIIT), the State Bank of India (SBI) opened a dedicated “state-of-the-art” branch for startups at Koramangala, a new-age business hub in Bengaluru. The country’s largest bank also has plans for similar branches in Gurgaon and Hyderabad, two other startup hotspots.

The developments come in the backdrop of the startup ecosystem seeing a steep decline in funds raised in Q3 2022. The funds raised by Indian startups in the first nine months of 2022 stood at $22 Bn, 19% lower than $27 Bn raised in the corresponding period of 2021 and almost 50% of $42 Bn raised in the entire 2021. 

The upheaval in global markets rules out the option of tapping the primary market too.

Interestingly, of the total $22 Bn funding raised by Indian startups in 2022, only about 3% was recorded as debt funding (as of September 24, 2022). This is almost 50% more than 1.8% debt funding in 2021 (of the overall funding), as per Inc42 data analysis. This indicates that the startups are certainly looking for more debt funding options in the Indian market.

The credit guarantee scheme and SBI’s startup branch, therefore, couldn’t have come at a better time as they open up more avenues in this funding winter and instil confidence in the startup community. The impact of these credit-facilitating measures in revving up funding activities will be keenly watched in the coming days.

Access to Formal Credit Channels Made Easier Now

The CGSS essentially aims at ensuring a smooth flow of credit to startups. Since exposure to individual cases is capped at INR 10 Cr under CGSS, the scheme is unlikely to renew big-ticket funding activities. However, it may boost investor sentiment.

Access to formal credit has been extremely low for new-age businesses because of the uncertainty and risks associated with them. Startups are generally cash-negative and, in most cases, have no real assets that can be pledged to secure a loan.

Given this background, the credit guarantee comes as a fresh lease of life for freshly-minted startups wishing to raise funds through the debt route.

Dedicated Bank Branches Are A Breath of Fresh Air

SBI would have studied the market before launching a dedicated startup branch. The need for such dedicated branches cannot be overemphasised, particularly in these difficult times. It is only a matter of time before more lenders, both in the public sector and private sector space, follow SBI and set up branches exclusively to meet the specific requirements of new-age companies.

A dedicated branch will be better equipped to study the market fit of a startup product or the technology risk of new-age businesses. The startup ecosystem will expect the dedicated branches, complemented by CGSS, to be a harbinger of change in accessing formal credit channels.

However, even with exclusive startup branches, access to bank credit can be easily ruled out for crypto and NFT for obvious reasons. It would be really interesting to see if these dedicated startup branches would extend loans, and CGSS would extend guarantee for credit facilities, to businesses in Web 3.0 space.

When Is Debt Ideal For Startups?

Startups seek debt to resolve issues such as cash flow mismatch. Debt is considered ideal when an asset is getting created on the balance sheet.

Startups may go for venture debt at any stage and deploy the proceeds for a variety of functions. The umbrella-based guarantee cover of CGSS will also provide a guarantee to venture debt funds registered under the AIF regulations of SEBI. The maximum cover in this space has also been capped at INR 10 Cr.

“Companies can use debt for financing working capital (for the inventory held, receivables from customers, advance paid to suppliers), capital expenditure (setting up dark stores, equipment finance, etc.) and acquisition financing,” said Apoorva Sharma, partner at Stride Ventures.

Startups may also take the venture debt route for better valuation at future equity funding rounds and to preserve equity. Veterans say equity is the most precious resource for any new-age business.

“We have seen founders get reduced to single-digit shareholding by the time they reach series C or series D, which impacts their ability to raise primary capital, resulting in a sub-optimal outcome for the company and the founders,” said Apoorva Sharma.

Debt should be clubbed in the capital structure in a measured way to preserve dilution, she added.

Venture debt comes in only when the company has raised $4-5 Mn in equity.

Investors From Tier-III, IV Cities Coming to The Fore

Even as debt funding is set to gain momentum in the immediate future, a new set of investors is emerging in Tier-III, IV cities of the country. Potential investors like ultra-high-net-worth individuals (UHNIs) and HNIs have been looking for inflation-beating investment opportunities.

About 80% of HNIs, UHNIs and family offices Anand Rathi surveyed earlier this year were looking to invest in AIF offerings, including private debt and private equity.

According to angel investor and We Founder Circle’s co-founder Gaurav VK Singhvi, the response his team received from UHNIs in startup meets in cities like Bhilwara and Kota in Rajasthan was “outstanding”.

We Founder Circle had met 750 investors in person in five cities—Jodhpur, Udaipur, Bhilwara, Kota and Jaipur.

“Cities like Bhilwara and Kota have never seen startup investors coming there and educating them about investing. As many 40 such investors were there in that room for the startup meet,” he said.

There are promising government schemes such as CGSS at one end of the spectrum, while on the other end entrepreneurs in small cities are evincing interest in investment opportunities in startups. We have seen more banks coming up with their startup-focus funding programmes, revenue based financing solutions, along with corporates taking interest in new age tech businesses. 

Nevertheless, multiple funding sources are a sign of the healthy expansion of the startup ecosystem. It gives founders a choice to not dilute their equity at an early stage while getting access to the required working capital, which is certainly the need of the current hour.

Note: We at Inc42 take our ethics very seriously. More information about it can be found here.

Inc42 Daily Brief

Stay Ahead With Daily News & Analysis on India’s Tech & Startup Economy

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