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India: Venture debt firms see pick-up in demand as equity deals slow

 for DealStreetAsia,
The slowdown in the availability of equity funding and a downward pressure on valuations in the venture capital ecosystem in the country has emerged as a business opportunity for firms which lend to technology start-ups.

Lending to start-ups is referred to as venture debt, and is substantially different from regular corporate lending which is generally asset-backed and provided to profit-making companies. Venture debt firms lend to new economy start-ups which are high-growth companies, asset-light and might have cash burn.

Typically venture debt firms charge interest rates in the mid teens, while equity investors look for returns which are above 25%.

While 2015 was a record year for venture capital (equity) funding, with $5.4 billion being invested across 473 deals, a majority of the investment activity occurred in the first half of the year. The second half of the year saw a marked slowdown, as several start-ups, especially in the food-tech sector, struggled to raise funds and had to scale back operations to conserve cash.

Temasek-backed InnoVen Capital closed 2015 with a lending of Rs.275 crore to 27 start-ups, the best year for the non-banking financial company (NBFC) since it started operations in India in 2009.

The firm has lent close to $150 million since starting operations here, having backed 70 start-ups so far.

“Recently, we have seen that equity capital is not easy to come by, so this (venture debt) becomes an important diversification tool for founders, said Vinod Murali, managing director at InnoVen Capital India, adding that there is a growing realization among start-up founders that equity is not the only source of capital.

“In the global arena too, venture debt has taken off with a lag with venture equity, I think even in India we are seeing that happen at this stage,” he added.

Trifecta Capital, which is registered as a category II alternative investment fund with the Securities and Exchange Board of India (Sebi) and has raised over Rs.200 crore from investors such as RBL Bank Ltd and others, is a relatively new company involved in the business.

Since starting operations in October, the fund has already lent Rs.50 crore to four start-ups and is witnessing a strong pipeline of deals.

“Clearly there are times when equity is available more easily and valuations tend to be more flexible, but what we are seeing in 2016 is that valuations are under pressure. Companies are realizing that they need to stretch their money as far as they can,” said Rahul Khanna, founder and managing partner at Trifecta Capital.

“In many ways, venture debt taken along with or after an equity round can give the company a three-to-five-month runway, which could mean a difference between raising money at X valuation or 1.5X valuation,” he said.

Apart from providing additional capital source to start-ups, venture debt has other benefits such as helping start-up founders reduce their equity dilution, while looking to raise capital to fund growth.

“To some extent if they are raising money and they are not getting the terms they want, then taking venture debt also helps in terms of dilution. For example, a start-up looking at raising $10 million, and not getting the targeted valuation, can raise $8 million in equity and the remaining $2 in debt, thereby reducing the equity dilution,” said Khanna.

Venture debt providers are hopeful that the current momentum in business will continue in 2016, given the current scenario in venture equity funding and the strong deal pipeline that they are witnessing.

InnoVen Capital is targeting to lend around $65-70 million (approximately Rs.350-400 crore) this calendar year.

“The final number would depend on opportunities, but we are feeling comfortable with that kind of estimate,” said Murali, adding that a recalibration is happening in the industry, which is making business more efficient and cutting flab.

According to Khanna, Trifecta is looking at making one or two investments every month, going ahead, with a ticket size ranging from Rs.5 crore to Rs.25 crore.

“Lot of financing activity happened in last 18-24 months, and many of those companies were consuming cash pretty quickly. So these start-ups are now looking at extending their runway, we are seeing some of that activity play through,” he said.

 

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