How do I raise capital for my start-up without giving away too much of my own equity? It’s every founder’s nightmare.
Today most entrepreneurs in Southeast Asia raise capital the old-fashioned way: Selling equity in their start-ups to early stage investors. The minus? Founders must give up a stake in their company, often at a low price.
What, then, if you want capital but don’t want to give up shares? Venture debt might be for you.
What is venture debt?
Simply put, venture debt is a loan. It is normally provided by banks to specialty venture debt funds. It’s usually a lump sum of cash paid back over time, with interest.
There are some attractive reasons for Southeast Asian entrepreneurs to use venture debt: you don’t give up equity, you don’t have to figure out a valuation for your company, often an onerous task for a start-up with scarce earnings, interfering investors don’t control your board and interest rates, especially for SMEs, can be pretty attractive.
Sounds excellent, doesn’t it? Now here’s the catch.
Normally, venture debt is available to companies who have secured a minimum of one round of venture capital. That means that it is very rare to hear of seed or pre-seed venture debt rounds. Even Facebook used venture debt only after raising an initial angel investment from the likes of venture capitalists like Peter Theil.
There are exceptions, of course. If you have significant physical assets, like expensive machinery that can be resold, you might qualify for venture debt. Alternatively, the government of the country where your start-up is domiciled steps in to underwrite your venture debt. In Singapore, for example, there is a popular venture debt loan offered by commercial bank OCBC (and other Singapore banks) that enjoys the backing of SPRING Singapore, a government body established to promote start-ups in the city-state.
Most of the time, though, banks and lending institutions rely on the specialized knowledge and industry experience of venture capitalists to pre-judge the debt worthiness of your start-up. Put another way, the banks are hoping that venture-capitalist money will keep your start-up afloat until until the expiry of their venture debt loan term.
Because venture debt guards against the dilution of their equity stakes, most venture capitalists are actually more than happy to work with banks to get their start-ups venture debt. “I would recommend it {venture debt} to all start-ups which are already venture-backed and need additional capital to scale,” says Igor Pesin, Investment Director at Singapore-based Life.SREDA, Southeast Asia’s largest fintech fund.
A mix of venture capital and venture debt is optimal, Pesin says. “Venture capital is not only the money, but it’s also the huge value that start-ups get from investors. We spend a significant amount of our time bringing large value to start-ups: mentoring and education, knowledge and experience sharing, networking, establishing of strategic partnerships, helping with exit scenarios, etc.”
As for the banks, there is a strong financial motive for them to offer venture debt as part of their loan portfolio. “By acquiring start-ups as a client at the beginning of their business development journey,” Pesin says, “banks are able to build relations with companies that might be the unicorns of tomorrow.”
Venture debt isn’t perfect, to be sure. After all, there is an actual loan and interest to repay. But if your start-up is at the right stage of growth, it may be your best option.
source: inc-asean.com
