Venture debt gaining traction in India: Diaz

Securing a traditional loan from a conventional lender may no longer be the only option for start-ups. “Growing companies can get much needed capital without giving up equity or control through venture debt,” said an executive involved in the early-stage investing.

Pointing out that most of the first-generation entrepreneurs lack basic collateral to offer to banks, the executive said that early stage entrepreneurs do not realise that raising equity can eventually become more expensive than debt, and tend to rush headlong into it without researching the consequences.

“Several start-ups find it difficult to raise conventional debt in their initial phase of the business, given their asset light nature of businesses,” sais Arun Diaz, Interim CEO of IntelleGrow, a financial intermediary that provides missing debt finance and skills support. “Promoters are now turning to venture debt as an appropriate mode to raise debt, grow their business and then reach out to investors and dilute less and ultimately command a better valuation for their business,” Diaz told BusinessLine , in a recent interaction.

Venture debt allows start-ups to borrow money even if they might not be creditworthy from a traditional debt perspective. But why would a lender be willing to risk his funds with a start-up whose business is not yet established? “The lender would probably earn a higher return on his loan than he would with most established companies. But certain questions need to be asked: is the risk reward ratio worthwhile,” said Diaz, and added, “because most lenders feel in their bones that the equation does not stack up they therefore, stay away from such transactions.”

As capital invested by venture capital (VC) firms and angel groups can be highly dilutive to founders, most are turning to venture debt as a means to fill the gap between highly dilutive capital events and traditional bank loans that are either not available for start-ups or are too restrictive.

Stating that there are some lenders “who think they have cracked the problem and are willing to take the risk provided some conditions are satisfied,” Diaz said, “If the lender obtains a good understanding of the business model, there is already a proof of concept in place and he believes that the company has a good chance of success. It also makes sense if institutional investors such as a venture capital or private equity fund have invested in the company and are prepared to continue backing them.”

“In addition to a higher rate of interest, the lender also takes warrants which would provide him an option to buy the company’s shares at a discount to the next round of equity investment,” said Diaz.

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