Investing in startups is oftentimes misunderstood. Contradictory to most of the literature written about investing over the years, it is deemed more art than science. Intuition, innovation, and risk-taking lie at the core of venture capital (VC) investing. According to IBM's Institute for Business Value and Oxford Economics, nine out of 10 startups in India fail within the first 5 years owing to limited funding alternatives, inadequate formal mentoring, and many other reasons. Ergo, banking institutions, which are placed on the other end of the risk spectrum, have historically distanced themselves from the startup universe.
The winding journey of a startup is marred by a plethora of reasons, but financial indiscipline is a recurring one. Hence, the decision of the Reserve Bank of India (RBI) to bring startups under the ambit of priority sector lending (PSL) norms comes as a significant boost for the ecosystem as novel avenues of capital, financial and otherwise, have now opened for these fledgeling companies.
Synergy in developing a banking relationship for startups
Akin to a parent’s evolving role through different stages in their offspring’s life, financial institutions can play a pivotal role at each stage of a startup’s journey. In the early stages, their importance could be defined by ease of banking and working capital solutions. This would evolve into liquidity management, strategic planning, and advisory during the growth phase. In the age of the knowledge economy, a growing number of companies are looking to transcend international borders and venture into the U.S., Europe, and other parts of Southeast Asia.
A well-equipped banking partner can act as an enabler for this purpose. Banks have much to gain from this marriage as well. The startup ecosystem is well poised to drive digital adoption in India and hence, will be the real delta driving the economy in this decade. By identifying and partnering with the right startups, banks can participate in their success stories by deeply entrenching themselves into the businesses as they scale. Various cross-sell opportunities exist with scalable businesses enabling banks to build a large-scale liability franchise with startups.
Funding landscape for startups and need for banks to play a role
Accessibility of financial capital has been imperative for the development of emerging growth companies around the globe. Equity financing has played a dominant role in this domain. In recent times, venture debt, too, has emerged as an important alternative source, allowing founders to create a steady credit track record while avoiding dilution of their ownership. However, banks can greatly solve the rigidity and lack of innovation inherent in the prevailing sources of capital.
Banking institutions can accommodate the unique nature of each business due to its comprehensiveness and scale, which gives them a competitive advantage. Equity capital rendered encumbered due to receivables in the case of B2B businesses and receivables and inventory for B2C businesses can be replaced by working capital credit extended by these institutions. This leads to efficiency and flexibility of financial resources. Furthermore, by partnering with VC institutions, banks can leverage their underwriting processes and networks for improving efficiency and achieving scale.
The winding journey of a startup is marred by a plethora of reasons, but financial indiscipline is a recurring one. Hence, the decision of the Reserve Bank of India (RBI) to bring startups under the ambit of priority sector lending (PSL) norms comes as a significant boost for the ecosystem as novel avenues of capital, financial and otherwise, have now opened for these fledgling companies.
Banks’ expectation from investments in the startup ecosystem and expected impact of PSL
In startup investing, a VC’s perspective is incomparable to a bank’s perspective. Hence, the startup must also be primed for the latter to understand what banks may seek in partnership. Fiscal prudence and liquidity management are indicative of a business’s path to profitability and hence, bank readiness. An entrepreneur must strike a balance between growth and long-term profitability. Similarly, corporate governance standards as well as the integrity of data must conform to the highest standards. Transparency and trust are imperative for banks to ensure scalability of the relationship.
The move made by the central bank stems from the rapidly growing role of startups as the engine of our vibrant economy. Banks, too, are getting their feet wet and joining hands with key stakeholders in the ecosystem. The time is now ripe for entrepreneurs to propel this culture shift.
Views are personal. The author is founder and managing partner, Stride Ventures.