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Venture Debt Firms Smell Opportunity Amid Funding Winter

With venture capital investors going slow on deals, venture debt is stepping in to fill some of the gap.

<div class="paragraphs"><p>(Photo: Andre Taissin/Unsplash)</p></div>
(Photo: Andre Taissin/Unsplash)

Following a record year for venture capital investing in India in 2021, investor firms have become shyer about deploying gunpowder this year. Change in public market and macroeconomic conditions may have deterred VCs, but venture debt investors see it as an opportunity.

Though the opportunity is lucrative, venture debt remains a fraction of VC investing in India. Venture debt deals worth only $0.5 billion were signed in 2021, as compared to $35 billion worth signed by VCs in the same year, according to data from Tracxn. But the current restraint prevailing at VC firms has generated more demand for venture debt and such investors are increasingly keen to step in.

“On average we do Rs 200-250 crore of disbursement in a month. [Now] we’ve started seeing a demand of Rs 1,000 crore a month,” Ishpreet Gandhi, managing partner at Stride Ventures told BQ Prime. Investors typically put in venture debt with a time horizon of four to five years in mind and expect a return in the range of 17-18%.

The cost of venture debt is undeniably expensive, but it also reflects the risk the debt investors take in investing in younger companies.

Without the high returns, “it wouldn’t make sense for their business models,” Raja Lahiri, partner at Grant Thornton India, told BQ Prime. Venture debt investors can step in when VCs want to reduce their exposure, but such debt investments go hand-in-hand with equity investments and cannot work without them, he added.

Startup founders were typically shy about taking on venture debt last year because of the additional cost that comes with it and the lower valuations offered by such investors. But that trend has now reversed.

Even as VCs have slowed down deal flow, companies continue to need capital and are hence turning towards venture debt, according to Navin Honagudi, general partner at VC firm Elev8 Venture Partners.

The shift “turns out to be counterintuitive for venture debt investors, because they are looking for far more equity comfort,” he added. Venture debt investors have typically invested in firms in later rounds such as Series C or D, but they have now started participating in large, early-stage rounds as well, Honagudi said.

“In the last three or four months, we have seen significant increase in demand for bridge-to-series-A or seed extension loans,” Vijay Lavhale, co-founder of 8vdx, a venture debt marketplace, told BQ Prime. 8vdx operates a platform for investors and firms seeking venture debt and its investors are typically high net worth individuals.

Enterprise software companies and buy-now-pay-later fintech providers are specific sectors which are especially primed for growth in venture debt investing, according to Ravi Chachra, co-founder of 8vdx. The predictability of cash flows in enterprise software and the high capital churn at buy now pay later firms makes them lucrative for venture debt, he added.  

Working capital, acquisition finance, and runway extension are the main uses founders prefer to deploy venture debt for, according to a report from Stride Ventures. While venture debt has been deployed across sectors, fintechs received 47% of the all funds invested as venture debt, the report noted.

Even though fintech lending appeals to venture debt investors as a sector, it’s important for them to be picky in a high-demand environment, the founder of fintech firm that has received venture debt investment, told BQ Prime on the condition of anonymity. If the startup’s business goes south, the debt investor could be left holding warrants and equity that have sharply reduced in value, this person added.

“If a company goes under, what am I gonna do with your domain name and the [Amazon Web Services] credits?” Chachra said. Venture debt investors therefore have to be much more selective about which firms they invest in, he added.

“When the liquidity has dried up and equity checks are not available, demand for venture debt always goes up,” Sagar Agarwal, managing director of VC fim Beams Fintech Fund, said. Even though there is sizeable demand, unless venture debt can become a cost-effective source of capital, it doesn’t make sense for firms to raise money at 15-18%, he added.

While venture debt has gained traction currently by playing the role of a band-aid, going forward their growth is likely to depend on how well they can pick their investments. Attracting a supply of funds, on the other hand, will depend on whether they’re able to keep pace with investor expectation on returns without making the funds cost-prohibitive for investors themselves.