How Venture Debt Is Reshaping Early Stage Funding In India

India’s startup ecosystem is entering a new growth phase, with venture debt transforming early-stage financing. It has emerged as a pivotal financing medium amid fluctuating market conditions while offering a complimentary pathway alongside venture equity (VE) for startups, specifically at the seed A and funding stages. 

Over the years, venture debt has grown popular across various startup stages and sectors in India. Even on a global level, the venture funding market, specifically debt, has risen due to the emergence of alternate lenders such as large private equity firms and alternative non-bank lenders gaining a foothold in venture lending.

 A study by Deloitte shows that US tech venture debt could rise to $14–16 Bn in 2024, a significant surge of 25% when compared to 2023. Demand for venture debt by companies to raise funds has been on an upward trend globally as well as in India. Looking from a microscopic lens, debt funding in the country has witnessed a remarkable 80% year-on-year surge in the first half of 2023, accounting for 4.81% of the total $5.4 Bn raised by Indian startups.

Venture Debt: A Paradigm Shift

Historically, venture debt was perceived sceptically, often associated with businesses facing difficulties raising equity rounds, and led to scepticism about the potential for successful exits from such investments. It further ignites debates over the distinction between traditional performing credit and venture debt, especially regarding the treatment of businesses with positive EBITDA. 

Some argue that profitable businesses should not be burdened with the additional requirement of warrants, suggesting an industry-driven bias aimed at reducing the cost of capital for these EBITDA-positive entities. 

Contrary to popular notions, venture debt is not limited to distressed startups. Well-performing startups are proactively using venture debt to extend their runway, meet milestones, and negotiate better equity outcomes. The strategic use of debt is helping founders steer through capital-intensive growth phases efficiently.

The Role Of Venture Debt In Early-Stage Financing

Venture debt serves as a bridge for companies transitioning to a stage where bank financing becomes viable. In high-interest rate environments, it aligns risk and returns efficiently, offering short-term, cash flow-generating opportunities for investors, with equity kickers or warrants improving potential returns. 

This financing mechanism instils deep financial discipline within startups, necessitating a balanced approach to capital management. It is crucial to note that venture debt and equity serve as complementary wheels of the capital system, not substitutes, each playing a distinct role in the startup’s growth trajectory​​.

Becoming An Institutional Investment Class

Initially catering predominantly to late-stage unicorns, venture debt is now tapped by companies across funding cycles – seed to pre-IPO – as alternatives like revenue-based financing gain ground. Venture debt has also gained immense popularity among Indian startups looking to raise capital.

Since CY19, the Indian venture debt market has grown at a 22% CAGR, with almost $1 Bn invested in CY22, beginning to mirror the global trajectory of this asset class. In the first half of 2023 alone, nearly 13 venture deals amounting to $174 Mn boosted the Indian startup ecosystem. 

The appeal of venture debt lies in its ability to provide capital with minimal equity dilution, making it an attractive proposition for founders. It has found strategic use cases, including M&A financing and growth financing, signalling a broader acceptance and integration into the financial strategies of startups​​.

Conclusion

As startups realise venture debt’s advantages, adoption is forecast to keep rising, echoing global markets. The asset class remains poised for significant expansion as investors seek diversified exposure to high-growth startups. 

There is vast potential and open doors for venture debt firms to establish themselves as reliable financing partners for startups across all stages of the entrepreneurial journey in India. 

As the market expands and diversifies, venture debt will likely play an even more significant role in the country’s startup success stories, driving innovation and growth in the years to come.