Inside India’s Venture Debt Funding Boom

A liquidity crunch and heightened focus by VCs on valuations and profitability have triggered the need for an alternative asset class to meet the financing requirements of fast-growing startups

Venture debt, which has been present in India only for the last 5-7 years, has now emerged as the preferred way for startups to access capital quickly

Indian startups raised about INR 4,500 Cr of venture debt last year, more than twice the amount raised in the year before

The funding winter has been gaining pace globally. In line with this trend, Indian startups have continued to witness a decline in equity funding with the number of deals falling significantly in H1 of 2022. 

This liquidity crunch, combined with a heightened focus by VC investors on valuations and profitability, has triggered the need for an alternative asset class to meet the financing requirements of fast-growing startups. Venture debt, which has been present in India only for the last 5-7 years, has now emerged as the preferred way for startups to access capital quickly.

The Appeal Of Venture Debt

Venture debt is a form of financing suited for high-growth startups that have high working capital requirements but lack tangible assets or sufficient cash flows to access traditional bank lending. 

It is fundamentally a founder-friendly and comparatively cheaper financing option, as it helps them avoid over-diluting shareholder equity at the early stages of a company’s growth. Venture debt can also help extend the cash runway for the company between equity rounds without compromising on the growth metrics caused due to uncertainty of capital. This helps companies navigate unforeseen market volatility or bridge short-term capital traps.

Venture debt is not a direct substitute for venture equity though, and in fact, complements it by offering an avenue to access new funds to expand existing capacity and augment their capital base. 

Ultimately, with a combination of venture equity and debt, young enterprises can strengthen their balance sheets and develop an optimal funding structure that makes them better positioned for long-term growth across economic cycles. Over the past few years, founders have started to use alternate sources of capital increasingly. This has resulted in rapid growth in venture debt, which is likely to continue in the Indian startup ecosystem. 

For investors, venture debt is an attractive asset class that offers regular returns and is a good way to get exposure to the start-up ecosystem without the long wait to get their capital back.

Increasing Momentum In India

Indian startups raised about INR 4,500 Cr of venture debt last year, more than twice the amount raised in the year before. Over 100 companies raised venture debt in 2021 including Mensa Brands, Urban Company, and Licious, among others, with ticket sizes ranging from $2-25 Mn. According to Venture Intelligence reports, India’s venture debt funds raised $85 Mn in 2020-21, an increase of $62 Mn compared to the previous financial year. 

In the first 5 months of 2022 (as of May 23), venture debt activity comprised 29 deals worth $190 Mn, compared to 33 deals of $136 Mn in the same half year 2021.

However, it would be fair to say that the venture debt market is still at a nascent stage in India and has a long way to catch up with its peers in the US and Europe where venture debt has been around since the 1970 and 1990s respectively. 

In these more mature markets, venture debt figures have been in the range of 15 – 20% of total venture capital funding. In India, venture debt figures are currently only between 2 – 4% of venture capital deals. 

While the concept may be catching up fast in India, it is currently highly underpenetrated. According to a venture capital report by Bain & Company, India’s active investor count in venture capital investments reached 665 in 2021, By comparison, there are only 6 venture debt managers in the market. 

Given the long-term trends in venture capital funding, various economic tailwinds and a growing appetite for private market deals in India, the venture debt market can easily grow to $3 – $4 Bn in the next couple of years. 

Factors To Consider

Startups interested in venture debt should consider the capabilities of their funding partners. Much like when looking for a corporate banking partner, startups should think of what network their lenders have as well as other value-added services they can provide. 

For instance, if a company is seeking to expand internationally, a local venture debt lender may not be able to meet the company’s offshore financing needs. Besides financing, startups may also find themselves in an unfamiliar regulatory and legal landscape. Having a trusted partner with international experience and network can significantly make the founder’s life easier in these cases. 

Ultimately, there are many ways in which venture debt can prove beneficial for a company and with rising awareness, venture debt will continue its upward momentum to support India’s vibrant startup ecosystem.