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What is venture debt & how does it differ from Equity funding?

venture debt is basically a debt instrument.

Venture debt, also known as venture funding, is a capital raising instrument used mostly by early and growth stage startups. Although venture debt is still not as popular as equity funding, over the years it has come of an age after gaining acceptance among investors as well as startup companies. Some of the leading startups that have raised capital through venture debt are Shopclues, BigBasket, Swiggy, Curefit, Yatra and Pepperfy. In 2017, startups raised nearly $150 Mn (Rs 1,000 crore) via venture funding route and these numbers are most likely to shoot up by considerably margin by end of the current year.

As the name suggests, venture debt is basically a debt instrument, which technically implies that it is a loan. However, unlike traditional loans, venture funding does not demand any collateral from startups. Instead it is offered against a legal agreement inclusive of terms & conditions that startups are obliged to fulfill. These terms and conditions may include paying principal amount & interest rates generally within 3-4 year period, offering investors equity stake in the form of share warrants and offering stake in company’s brand, intellectual property and fixed assets.

Most of these terms and conditions are variable and are mostly mutually decided after exhaustive discussion between venture lender and the concerned borrower.

Venture debt offers several advantages that Equity funding doesn’t            

The many great benefits offered by venture funding surely makes it a worth trying option for startups and small companies.        

  • It leads to less equity dilution for entrepreneurs.
  • It does not take into account market valuation of the business
  • It is less costlier then equity funding
  • Venture lenders generally do not demand any seat in the board of director’s team and hence they rarely interfere with company’s day-to-day affair.
  • The due diligence process generally carried out by the venture lenders is far more lenient.

Even investors stand to benefit greatly from venture debt on several accounts. But the most important benefit is the fact that investors are spared from waiting for unduly long years to make an exit. All they to do is to make sure that the concerned party pays the principal amount and interest rates within the stipulated period of time. However, investors have to contend with lower returns that normally vary from 15-20% as compared to 25-30% on equity funding.

When should startups opt for venture funding?      

There are no definitive and conclusive answers about when should startups really go for venture funding. But a startup should certainly carry proper due diligence about its cash flows and cash reserves before taking the final plunge. If it is confident about maintaining strong cash flows for sustainable period of time then taking venture debt route will surely prove to be a good business decision.

Proper due diligence of cash flows is very critical because startups have to bear in mind that, unlike equity funding, venture debt incurs loan repayment along with interest rates. If the startup fails to repay the loan then it may have to face many harsh consequences including complete dilution of the company.

Lastly, any startup that wants to avoid equity dilution at any cost must surely consider taking venture debt route.

Which institutions provide venture debt?

Generally, traditionally banks desist from providing venture debt services, leaving the gap to be filled by modern day aggressive banks and venture capital firms. Venture debt is essentially an integral part of the global venture funding market and hence the mantle of providing this popular debt service has been mostly taken over by venture capital firms.

There are several well-known VC firms in India that have dedicated venture debt fund. Some of the leading ones are as follows:

  • Innoven capital
  • Trifecta capital
  • Alteria capital
  • Capital float
  • Lending Kart
  • IFMR Capital
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