How Venture Debt Is Coming To The Rescue Of Start-Ups


Nilesh Kothari (left) and Rahul Khanna, managing partners, Trifecta Capital

Back in December 2012, Kunal Bahl of Snapdeal was buying time. The e-commerce start-up that he founded with school friend Rohit Bansal was in the middle of a fund-raising round. He had some offers on the table, including from eBay, the US-based online marketplace.

Though Snapdeal had been registering a significant improvement on most parameters – gross merchandise value, web traffic and number of users – Bahl wanted more time so that he could show even better performance and get a higher valuation. This, after all, would have got him more money. But waiting was difficult as the company was burning cash like nobody’s business.

It was around this time that Vani Kola, Managing Director of venture capital firm Kalaari Capital, among Snapdeal’s early investors, introduced Bahl to Vinod Murali, Managing Director of InnoVen Capital India (known as SVB India Finance at the time). Murali met Bahl, studied the business for about three weeks, and gave a $1.5 million loan. “We gave them flexibility of a few months that allowed them to identify the right [equity] partners,” says Murali. In June next year, Snapdeal raised $50 million from investors led by eBay at a valuation of around $500 million. Murali was paid back and the deal closed.

InnoVen Capital is part of a growing tribe of financiers in India who provide venture debt – a new form of financing, typically short term, that is playing the twin roles of a protector and a buffer for cash-hungry start-ups.

Venture debt is a mature asset class in the west. It comes to life 10-15 years after the venture capital market matures. For instance, in the US, venture capital was a 1970s phenomenon. Specialist debt providers began to emerge in late 1980s.

In India, too, the venture capital market grew from $300 million in 2005 to $2.1 billion in 2014, a glut that prompted start-ups to use equity capital from venture funds for all their needs. However, the market has now matured, and there is a realisation among both companies and venture funds about the need for short-term capital.


Start-ups need capital, usually a lot of it. For this, promoters typically sell stake to venture capitalists (VCs) or angel investors. Since most face liquidity issues, they rely on venture funding – which requires selling a part of the stake – for short-term needs as well. But selling equity for working capital is not advisable. Of late, there has been a realisation among VCs and companies that short-term capital for things such as salaries, raw materials and running operations should come from either cash flows or debt.

But in India, banks and non-banking financial companies, or NBFCs, are not comfortable lending to start-ups. This is because their lending models are built around collaterals such as machinery, plant and cash flow. Most start-ups don’t have these. Also, banks’ lending guidelines revolve around asset classes and so they find it difficult to understand new economy businesses. But start-ups have the same needs as established businesses. That’s where venture debt firms step in.

“We realised that there is a huge challenge of providing debt to businesses which are zero to four years old. They find it difficult to get short-term money and, therefore, depend on long-term equity capital. Raising equity for meeting short-term requirements is inherently wrong,” says Sanjib Jha, CEO and Director at Mumbai-based IntelleGrow, a provider of venture debt that started in 2012. He says equity funding must be for long-term expenses such as buying land or plant, expansion and innovation.

Take Faasos, an online food technology company. In 2014, it had `15 crore cash in bank, but that was not sufficient to fund its plans, which included expanding presence to more cities, building a supply chain and setting up a technology platform. It had not envisaged these investments when it last raised equity capital in 2012. In April 2014, it raised `6 crore from InnoVen which was used mainly to build the technology platform, including a mobile app. “We didn’t want to stop expanding at the expense of doing something else,” says Revant Bhate, co-founder, Fasoos. In March this year, the company raised $16 million from venture capital funds.

Like Fasoos, many start-ups are using venture debt to get extra runway between two rounds of equity funding.

Venture debt, just like bank loans, has to be paid back in two-three years. The interest cost is 15-24 per cent, higher than the usual rates of 12-14 per cent, because of the higher risk involved in funding start-ups.

“Borrowing is not easy for start-ups due to their low asset base and weak cash flows. Venture debt is a bridge-gap arrangement,” says Shefali Goradia, Partner, BMR & Associates.

Once the loan is given, borrowers start paying back – both interest and principal – on a monthly or quarterly basis based on their cash flows (just like equated monthly instalments). Some lenders give a moratorium of three to six months.

One of the biggest advantages of venture debt is that it protects ownership. In the past, start-up founders had little option but to dilute stake to raise capital. This is no longer the case. Assume that a company has to sell a 25 per cent stake for raising $5 million. If it gets access to venture debt, it has an option of raising $4 million equity and $1 million debt so that the stake dilution is only 20 per cent. If the company is valued at $1 billion two years later, the 5 per cent stake the founder has managed to retain will be worth $50 million.


While there are hundreds of venture capital funds, the number of venture debt companies is limited. And each follows a different model. Take InnoVen Capital. In 2008, Silicon Valley Bank set up its India arm, SVB India Finance, which provided credit to start-ups without collateral. It was the first venture debt company in India and started around the time the venture capital market was taking off. “You need a stable venture capital ecosystem for this asset class to survive. When we started, venture capital itself was new, and venture debt was unheard of. The first two-three years were difficult,” says Murali.

With a corpus of $50 million, it has done around 80 transactions with 55 companies, including Myntra, Freecharge, Practo, Yatra and Firstcry. Its focus areas are digital media, clean tech, financial services, technology, consumer and health care. InnoVen works with over 30 VCs, including Accel Partners, Bessemer Venture Partners, Kalaari Capital and Sequoia Capital.

Singapore’s sovereign wealth fund, Temasek Holdings, also got attracted by the potential of the venture debt market and acquired SVB India for around `300 crore to expand the venture debt platform to Asia, starting with Singapore.

While equity investments have long tenures (seven to 10 years) and ticket size of over $10 million, the venture debt amount is much smaller. For example, InnoVen’s average loan size is $1.5-2 million. Its direct competitor, IntelleGrow, keeps the ticket size below `10 crore. State-run Small Industries Development Bank of India (SIDBI) has a cap of Rs 2 crore per investment.

Each firm has taken a different route to tap the market. For instance, InnoVen Capital lends to companies where there is an equity investor. It co-invests or comes right after the equity round. Trifecta Capital, which is in the process of raising `500 crore from banks, insurance companies, large family offices and endowments, plans to follow the same model.

“Our debt will be about 20 per cent of the most recent round of equity funding. So, if someone has raised $5 million, we will provide $1 million,” says Rahul Khanna, Managing Partner, Trifecta Capital. Trifecta is the country’s first venture debt fund (others are NBFCs).

Some venture debt companies lend only to start-ups that have already been funded by VCs. The reason is that VCs are known to scan the huge universe of companies using their strict parameters before funding them. For example, last year, it is estimated that VCs funded some 250 companies after examining over 2,000 candidates. InnoVen picks a handful from this lot. Trifecta will also follow this model in the future. However, IntelleGrow’s Jha says his company does not rely on other people. “There’s difference between the attitude of VCs and lenders like us,” he says. “Equity investors give money in hope that they will be able to exit after five years. They start working towards an exit after three-four years. When I am giving money, my tendency is to start getting it back from next month. My due diligence has to be different,” he says.

IntelleGrow and SIDBI fund start-ups which are either equity- or promoter-funded. “We are sector-agnostic. We see if the company is growing fast, has strong management & internal processes and intentions to put good governance structures in place,” says Jha, adding that his target market is much larger – about $10 billion – than its competitors.

SIDBI, which has a venture debt corpus of `200 crore, has gone a step ahead. It has put in place a structure where it refers [companies] to bodies like NASSCOM and iSpirit. “We don’t have the technical expertise to evaluate companies. NASSCOM interviews company managements and understands businesses. We take a call based on third-party judgement and give loans without collateral,” says K.I. Mani, General Manager, SIDBI.


How do these lenders make money? For NBFCs, the income has two components – interest spread and equity options. Interest spread is the difference in their borrowing and lending rates. Industry experts say this alone doesn’t make venture debt attractive. As a result, the companies have come out with innovative deal structures that allow them to boost returns.

InnoVen, for instance, gets an equity kicker in the investee company. So, if a start-up has a strong exit event such as acquisition or listing, it benefits. The kicker is 10-15 per cent of the loan value. “We don’t get equity, it’s an option,” says Murali. Recently, when InnoVen’s portfolio companies – Myntra, Freecharge, Prizm Payment – were acquired, it generated decent returns.

Trifecta’s Managing Partner Nilesh Kothari says unlike venture capital funds, which take a lot of risk, they are looking for average returns. “We will lend at rates we believe are comfortable for the companies,” he says.

The caution exercised by venture debt firms has kept slippages around 4 per cent, significantly less than the deliquency rate in the venture capital space (40 per cent).

Except Trifecta, which will get non-convertible debentures from investee companies, other firms give term or working capital loans. “The debentures are senior and secured, which means we will get preference in the event of liquidation,” says Khanna. What if the investee company goes bankrupt? “Since we are co-investing with venture capital, we expect them to provide support to their portfolio companies in difficult times,” he adds.

Even with limited number of players, the competition seems to be intensifying. IntelleGrow’s Jha says his balance sheet is small compared to market leader InnoVen. IntelleGrow has plans to expand its balance sheet from Rs 225 crore to over Rs 1,000 crore in three years.

“We give loans for about three years. Our desire is it to take this to four-five years as our balance sheet expands. We are the only early-stage lender which is leveraged. InnoVen has not leveraged its balance sheet and is entirely funded through equity,” says Jha.

Back in 2008, four years before going public, social networking giant Facebook had borrowed $100 million venture debt for building infrastructure, primarily servers. The entire venture debt market in India is roughly twice as big. The Indian venture debt market is yet to come of age. But with more specialised institutions expected to set up shop, this area will see a lot of action in the future.

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What Is Venture Debt and How Should Startups Use It?




There’s been a lot of digital ink spilled around the various types of capital available to startups today. At NextView, for instance, one of our more popular posts centers on atypical seed rounds to know. Today, we wanted to share some basics of another source of capital: venture debt. What is it, and how should founders think about it?

As a startup grows, venture debt becomes a viable option to continue that growth. It can be lower cost and can either buy more time or accelerate growth. Below, we talk to Glen Mello, Managing Director of Silicon Valley Bank’s accelerator team in Boston. Glen is an active contributor to the local tech ecosystem and well-versed in how and when startups can use venture debt to their advantage.

NextView Ventures: What is venture debt, and how should startups approach it as a source of capital? What are some pros and cons?

Glen Mello: Venture debt is a good complement to equity. It’s generally got a lower cost compared to equity capital and can help support growth. You’ll also see some startups use it as an additional cushion. From a company milestones perspective, entrepreneurs who take on venture debt are almost always thinking about raising that next round of capital from other institutions.

One con is that it is debt, so it needs to be repaid. In a scenario where you have missed the milestones or you’re out raising at the same point where it’s amortizing and you’re starting to pay it back, it can be a challenge.

[Ed. note: We’d like to be extra clear that founders should not take on venture debt if they don’t have 100% visibility into repaying the loan, as banks that need to recoup their loan my force the company or you as the guarantor into liquidation or bankruptcy. Use good judgment, talk to your co-founders/investors/lawyers, and partner with a bank that values transparency and relationships such as SVB.]

NVV: How does venture debt differ from other types of traditional loans?

GM: The model is more about the relationship with the entrepreneurs, the investors, and us as the bank, as opposed to cash flow or fixed assets to lend on. The structure itself is very similar to traditional debt, as it has interest rates, it needs to be repaid, etc., but the underwriting of it is much different.

NVV: What stage of growth is appropriate for a company to have achieved prior to taking on venture debt?

GM: It becomes more useful as the company is continuing to grow — probably at a point after they’ve raised some institutional capital. Reason being, there’s more of a defined strategy for the company. In many instances, you raise an institutional round to either fulfill a product strategy or go-to-market strategy or you’re increasing sales and marketing hires, so you have better visibility into what needs to happen in the next six, 12, 18 months. Prior to that, there’s a lot that’s unknown, and so when you layer in debt that eventually needs to be repaid, it can complicate the process.

Especially in the early stages, so much about the company may change in how they think about product or go-to-market — and change multiple times — before raising an institutional round. So it makes it a lot more challenging when you have debt on the books that isn’t as longer term as equity. (Equity doesnt need to be repaid, so it’s a more “permanent” capital source.)

NVV: These investments seem to happen between institutional rounds. Why?

GM: There’s a fair amount that happens in parallel to VC rounds, but yes, it often happens when a company is fresh off of an equity raise, usually within three or four months. The reason it happens this way is that, again, there’s a buy-in from all the parties I mentioned. For the investors, there’s a plan they just invested in. For the founding team, there’s a strategy in place. And then the question becomes, “How do I complement the capital I just raised, either to buy more time in case I slip or to accelerate my spending if t?” Venture debt gives you those options, and particularly for companies that wind up doing well, then on your same cash-out date, you’d likely have achieved a better milestone thanks to fueling your spend, which would translate into a better valuation.

NVV: Let’s talk about the seed stage specifically. With venture debt as a source of low-cost capital to fuel growth or buy time during later stages, should a founder approach their fundraising from VCs any differently today?

GM: No. After you raise a seed round or other early rounds, I think that entrepreneurs should consider this a complement to institutional equity. There’s a perception in the market that they can just raise debt instead because it’s easier, and that’s a perception that’s probably not accurate.

Looking at current trends, companies are taking on debt sooner than they ordinarily would have before, in addition to taking on more of it in dollar amount. It’s not often a seed-stage company — usually it’s later — but the trends are going earlier and larger.

NVV: Walk me through the typical process once a startup approaches you.

GM: The first thing is really about spending some time with the entrepreneurs and walking through the model, their go-to-market strategy, etc.

If we don’t have a prior relationship, we’ll really want to try to develop that because it’s such a relationship play. And it’s that important because all companies will go through good times and tough times, and we’ll want to make sure we’ve got the right partner on the other side.

We’ll also dig into the model, dig into the product, dig into their go-to-market, and really try to understand and evaluate the milestones associated with getting to their next round of funding. These are value-creation milestones. We’re essentially looking to understand the probability of a company attracting more outside capital. If they can’t, then we want to know more about the existing investor syndicate, so we’re not the only ones at the table.

We’d then put together a proposal that would spell out all the mechanics, including the pricing. It includes the amount we’d be willing to do, maybe with some available up front and some available based on milestones so we’re funding their growth. We also spell out the interest-only period, the amortization period, the warrants, the interest rate, and then some high level legal terms we would include in the documents and highlight in the term sheet — similar to a VC term sheet.

In terms of negotiation, there are always hot buttons. It could be with the entrepreneur or the investors. But overall, it’s a really efficient process. Investors have typically seen our term sheets and documents before, and the startup’s lawyers have seen these too, so everyone knows the standard and what to expect. The fact that the process can be much smoother and quicker can actually be a benefit.

NVV: What do debt providers look for in a company’s track record? Traction and revenue? Business model? Previous capital raised?

GM: We look at things very much like a VC investor. We’d look at the team — if they’re a repeat entrepreneur, have a good track record, have built a quality team, and so on. We also look at whether we’ve had a prior relationship with them, whether good or bad. Then we look at our relationships with the company’s current investors.

We also consider the market opportunity. Are they way ahead of the market? Are they entering one of maybe many raises down the road, or are they late to the game? Maybe there are many players in the market where some have already been acquired and prices looked good. Or maybe there aren’t enough chairs left in the market for latecomers.

SVB also has an analytics group to use for industry stats, company statistics on a global basis, and so forth, so we collect a lot of data that we try to leverage internally.

NVV: How important is the accuracy or confidence in a startup’s cash flow prior to taking on venture debt? With equity, for instance, it’s likely the investment won’t be repaid when you look at the numbers of startups who fail. 

GM: Cash is actually a big piece of the analysis. Among the elements we look at are the burn, the cost to hit certain milestones or inflection points and whether or not there’s a buffer built in, whether we’re providing the buffer or the equity investors are providing it, and so on. So although the startup’s plans may change, understanding product and go-to-market milestones is pretty important. As an aside, it’s probably more important if there’s a significant hardware component to the product. Typically, the gross margins aren’t there compared to software, so revenue isn’t quite as important in the early stages of getting to market. But the costs are definitely there. If you’re way off on the cost of manufacturing or shipping, it can really impair a company at the point in time where it’s going to be raising more capital.

NVV: What are some stereotypical terms? What percent of the fair market value of a company’s assets is typically lent?

GM: It’s less about lending on the assets and more about those relationships. We’d look at a company and the relationship we have with investors, management team, founders, etc. first and foremost.

There used to be a rule of thumb that debt was around 25% of the fresh equity raised. That ratio is now getting skewed to much bigger percentages now, which goes to what I was saying earlier that there’s a lot of liquidity in the market and people are doing larger deals than they normally would have done.

NVV: Is there any dilution? Any equity the venture debt lender gets?

GM: There are warrants attached to these loans, but it’s a pretty nominal dilution and pretty low cost of capital for an entrepreneur, which is usually part of the appeal.

NVV: How long is the typical term? What interest rate is typical?

GM: The rate can fluctuate based on the prime rate, so there’s a chance it could go up. The chances of it going down are nonexistent today. The typical term is four years, which would include some period of interest only, and then it would start to amortize.

NVV: Any other terminology a founder should know in order to better understand venture debt?

GM: I think venture debt is used as a generalization. The way to characterize it simply and appropriately is that venture debt is term-oriented debt, which is different than something based on working capital. It’s really to help facilitate growth and complement some equity that’s raised. That’s the best way founders should think about it.

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