Venture debt to grow the businesses . Few real instances:
- Harassment of the founder: Revenues of company A fell beyond the expected levels which led to delay in the payment. The debt providers post 2–3 communication started harassing the founders for payment. As a result, the founder started losing the focus on operations, growth and fundraise which initiated a spiral effect wherein the business continued to decline, which led to missing of payment schedules which led to increased harassment.
- Proceeding legally again the promoter: On suggestion from a prospective investor, Company B raised venture debt to fuel growth. On achieving the revenue target, the investor declined investment. The company slowed down the growth engine and started laying-off teams. In the due course, the company ran out of cash. Unable to service the debt, multiple lawsuits were filed against the promoter. The promoter had to apply for bail and had to engage for a prolonged duration in the legal battles rather than focusing on recovering the business or self. The negative impact on the mental well-being of the team, promoter and their families cannot be ascertained.
- Haircut by the Venture Debt provider: Company C folded operations and negotiated with the Debt provider on restructuring the payment schedule and pay-outs. The payments were done by the promoter out of their own pockets and the Venture Debt provider absorbed some loss due to the haircut on payouts and increased timeline. The period of negotiations was toll taking on the founders and venture debt providers. The CIBIL score of the founders was impacted due to settlement
- Founders with contingency plan: The business is occasionally unable to generate surplus cash for EMI payment. Founders infuse cash out of personal savings in the company to meet the obligation for the months in which the company does not generate surplus. Founders personal savings are depleting but the company continues to progress and founders are at peace mentally and able to focus on business.
Lets understand more about Venture debt.
Introduction:
Venture debt is a type of debt financing that offers potential benefits and risks for start-ups. As an entrepreneur, it’s crucial to understand the nuances of venture debt before deciding whether it’s a suitable financing option for your business. In this blog, we will explore the concept of venture debt, its various types, its history in India, and the implications it can have on your start-up.
Understanding Venture Debt:
Venture debt is a non-dilutive form of financing provided to venture-backed companies. Unlike equity financing, it does not require giving up ownership or equity in the company. Instead, venture debt allows start-ups to raise capital while maintaining control over their business.
Types of Venture Debt:
- Credit Line: These are revolving lines of credit that can be utilized for working capital or other expenses on demand.
- Term Loans: Fixed-term loans that are commonly used to fund growth initiatives. They have a fixed interest rate and are repaid in monthly installments over a specified period.
- Revenue-Based Finance: Credit is provided based on the company’s revenue and cash reserves. Monthly payments are calculated as a percentage of revenue, subject to a minimum amount, for a specific period.
Venture Debt History in India:
The growth of venture debt in India has seen both challenges and opportunities. Initially, venture debt was accessible primarily to established companies with
- proven product-market fit,
- growth strategies, and
- backing from prominent private equity players.
It allowed companies to expand their business without diluting equity and provided a reasonable cost of capital, often higher than traditional debt providers.
However, the limited market and spread hindered the growth of venture debt providers.
In response, between 2015 and 2019, these providers began targeting growth-stage start-ups backed by venture capitalists before their private equity rounds. They provided debt to achieve profitability and facilitate subsequent rounds of private equity or initial public offerings (IPOs).
The Third Wave (2020–2022):
During this period, start-ups were frequently raising capital at high valuations but found the cost of equity to be a significant concern. Venture debt providers seized the opportunity to expand their target markets and promoted the idea of raising venture debt to avoid equity dilution. They emphasized that venture debt could improve a company’s credit rating, facilitating future capital raising.
Consequences and Risks:
However, the influx of venture debt resulted in overreliance on debt financing. When the availability of equity capital diminished, start-ups faced challenges in raising funds and servicing the high-cost debt they had accumulated. Negative bottom lines and debt servicing difficulties led to slower growth, stagnation, and, in some cases, company closures.
Managing the Risks of Venture Debt:
To effectively manage the risks associated with venture debt, consider the following tips:
- Understand Loan Terms: Thoroughly review and comprehend the interest rates, repayment terms, and debt covenants before signing any loan agreements.
- Monitor Financial Performance: Keep a close eye on your company’s financial performance to ensure compliance with debt covenants and stay on track for loan repayment.
- Have a Contingency Plan: Develop a contingency plan in case of default on the loan, such as asset sales, additional capital raising, or debt restructuring.
Recommendations for Entrepreneurs and Investors:
When considering venture debt, entrepreneurs should assess their company’s stage, financial position, and ability to service the debt.
Investors recommending venture debt to portfolio companies must consider these factors, along with other financial and non-financial metrics, to ensure it aligns with the company’s growth strategy and financial capabilities.
Venture Debt used to Finance Working Capital: Company E, raised venture debt to finance working capital. The founders and finance controls appropriately billed services to clients taking into consideration the finance cost and repayment requirements of the venture debt.
The payments were made timely, the company continued to grow and avail more and more venture debt to finance the working capital needs of the growing business.
Herein, optimum use of venture capital fuelled business growth unlike in many other cases where the sub-optimum use of venture growth pulled the business down.
The impact of Venture Debt forms ripple effect wherein,
- if used to fuel growth, the engine continues to fire
- If used to manage operational burn, the deficit continues to widen.
Re-emphasizing, founders should be diligent prior to availing venture debt and continuously monitor the application of venture debt in the business to ensure the best outcome.
Author:
Karan Gupta
