Last month, Quikr, an online classifieds company, raised ₹55 crore in venture debt funding from InnoVen Capital. The Bengaluru-headquartered unicorn was clear in its intention of putting the capital raised to good use: to scale its businesses. A few days later, Moglix, an online store for industrial tools and equipment, raised ₹164 crore from venture capital firms Accel, Jungle Ventures, and International Finance Corporation (IFC), besides venture debt firm InnoVen Capital, among others. In July, Mumbai-based executive education service provider Eruditus Executive Education raised venture debt of ₹16 crore from InnoVen Capital.

While raising funds by fast growing companies is nothing new, what stands out in these three deals is the participation of venture debt provider InnoVen Capital, a Temasek Holdings and UOB Group-backed specialty financing firm. Venture debt is typically provided by dedicated non-bank lenders to venture-capital backed companies that are looking for financing to support their working capital expenditure requirements. The key difference between venture capital and venture debt is that venture debt seldom comprises equity dilution by founders and promoters.

Over the last three years years, venture debt, a relatively new concept in India, has emerged as a strong asset class in itself. According to data tracking firm Tracxn, the value of venture debt deals rose to $63.4 million in 2018 from $61.7 million in 2017 and $58 million in 2016. A couple of firms are offering venture loans, including the likes of Alteria Capital and Trifecta Capital. Experts now believe that both the number of venture debt deals and such providers will go up this year.

To be sure, Mumbai-based early-stage venture capital firm Unicorn India Ventures is raising a ₹600 crore debt fund. Currently, it invests out of its ₹100 crore equity fund and its portfolio includes SmartCoin, a micro-lending platform; GrabOnRent, a rental marketplace; and digital-marketing-focussed artificial intelligence start-up Boxx.ai.

“We are investing in the early stage (Series A) space where debt would be difficult for companies to raise. Because we are in the thick and thin of the situation (due to our equity fund) we are better placed to extend debt to deserving startup and help them grow at the same time with less equity dilution,” says Anil Joshi, managing partner, Unicorn India Ventures.

What makes venture debt an attractive proposition for promoters is that this financing option gives them more time and flexibility to scale up and grow without diluting equity. Banks tend to shy away from lending without collaterals, which is an issue for most technology and other startups. Hence venture debt is being lapped up. For venture debt, the interest rate is often around 15% for up to three years, but could vary depending on the stage of the company. The interest rate is higher for early-stage firms, as the risk of mortality is high.

Interestingly, it’s not just startups but even unicorns that are keen on venture debt. InnoVen, for example, extended venture debt to seven to eight unicorns this year, including Swiggy, OYO, and Quikr, says Ashish Sharma, managing director and chief executive, InnoVen Capital.

“Companies raise venture debt for three broad reasons: It helps optimise the capital structure (due to less equity dilution); it optimises the return on capital (interest rates tend to be fixed and lower than equity returns) and it extends the runway for the company before it goes for the next round of fundraise,” says Sharma.

InnoVen offers venture debt from ₹6 crore to as much as ₹100 crore. It closed nearly 40 debt deals this year, of which 15 were follow-on financings to its portfolio firms.

Sharma believes the value of venture debt deals will grow by nearly 25-30% in 2019 on the back of increasing demand from companies, more players in the space and awareness about these financial offerings.

In the meantime, it’s not just venture debt but venture capital deals are also on an upswing. VC investors in the country pooled in nearly $3.5-4 billion till September 2018 across 400 deals, up from $3.4 billion invested across 515 deals in the whole of 2017, according to a recent report by Bain & Company and IVCA called ‘Perspectives on Indian VC Ecosystem 2018’. The increasing investment tickets and decreasing number of deals highlights what experts are calling a ‘maturing phase’ of early-stage investors in the country.

“VCs now more focussed on placing select bets on fewer investments, given their initial portfolios are already in place. Focus has shifted to fewer, higher quality deals. With increasing focus on quality, the number of deals has declined and deal size has increased across all investment stages,” says the Bain report.

The average VC deal size now is $8.7 million to $10 million compared with $6.6 million in 2017 and $3.8 million in 2016.

In the meantime, VCs in India have seen reasonable success. According to the Bain report, 5-15% of portfolio companies of large funds such as Sequoia Capital, Accel, and Nexus Venture Partners went on to cumulatively raise over $100 million in funding.

“Exit Momentum in India has been picking up over the past few years ($4.2 billion net VC exit value in 2017 vs. $1.3 billion in 2014), and is expected to accelerate in the future as the start-up ecosystem matures,” says the report.

Some 80% of start-up founders expect exits by 2024. Global limited partners (or LPs, investors in VC/PE funds) are beginning to take note of these stats. During the downturn of 2010-12, LPs had started questioning if the Indian market was strong enough for exits. Over the last few months, exits such as Flipkart (acquired by Walmart) have underlined the ability of the Indian market to return capital to LPs.

Hence, India is well positioned to attract high investments in the future.

“With exits like Flipkart, there is liquidity in the market and entrepreneurs such as Sachin Bansal (he co-founded Flipkart) are now investing capital in other startups. Secondly, when a company such as Udaan becomes a unicorn very fast (in about two years of its founding), it gives encouragement to others to follow their dreams; and thirdly, the new hybrid models of venture debt are viable for entrepreneurs as they dilute lesser equity, which gives them a path to raise more equity capital later,” says Padmaja Ruparel, co-founder at Indian Angel Network and founding partner of IAN Fund.

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