Startups increasingly raising venture debt as investors fear funding winter

Most investors are more cautious in deploying capital towards growth businesses, especially in late-stage startup investments, which are key drivers in a funding cycle

As global investors are preparing for a ‘funding winter’ and warning their portfolio firms of cost-cutting, startups are looking at different fund raising avenues such as venture debt, according to experts. India has witnessed a series of layoffs and startup valuations are under stress. A growing list of unicorns have fired employees.

According to experts, current macroeconomic and geopolitical factors are reasons for negative sentiments in global markets, including US tech equity market corrections and new-age business IPOs underperforming. Rising inflation rates, tightening monetary policy across geographies, and the Russia-Ukraine war further added to the market volatility. Investors are more careful in deploying capital towards growth businesses, especially in late-stage startup investments, which are key drivers in a funding cycle.

These reasons have resulted in companies looking at alternative sources of finance, of which venture debt is often the ideal solution, as it provides a stop-gap arrangement for such businesses. It is an alternative to equity, which would likely take place at lower valuations, thus resulting in higher dilutions until markets and valuations recover.

After the post-pandemic funding boost, the current geopolitical and economic scenario is a good reminder to focus on fundamentals, said Ankur Bansal, co-founder and director at venture debt firm, BlackSoil.

The cost-cutting for majority of growth companies has become paramount, as sustainability has become the need of the hour, he said, adding that this will result in companies burning cash for growth run out of steam.

"This is likely to result in a significant increase in consolidations/mergers and acquisitions," said Bansal. "And companies, having realised the benefits of onboarding venture debt as part of the financing mix (as it provides a relatively cheaper alternative to equity financing)."

BlackSoil's alternative investment fund (AIF) grew nearly 150 per cent in deal numbers and 2.25x in deal value year-on-year in the first quarter of FY23.

In August, digital payment solutions provider, MobiKwik, raised debt of Rs 35 crore from Blacksoil Capital, amid an IPO delay. The Gurugram-based firm raised the amount after more than 12 months of filing its Draft Red Herring Prospectus (DRHP) with the Securities and Exchange Board of India (Sebi).

Microsoft, in April, joined the convertible note funding round of e-commerce firm Udaan, which reached $275 million via convertible notes and debt. According to an internal company letter, Microsoft has joined new players M&G Prudential, Kaiser Permanente, Nomura, TOR, Arena Investors, Samena Capital and Ishana Capital.

Healthtech firm GOQii, also raised $50 million in a Series C funding round in 2022, led by Sumeru Ventures. The company raised funds across equity, preference shares, notes, and debt.

"In the current market environment, founders are looking to defer their equity capital raise given the valuation multiples have been lower than expected," said Apoorva Sharma, partner at Stride Ventures. "This has also allowed debt to become an important choice for startups to use in acquisition consideration, working capital or runway extension," she added.

On August 17, Stride Ventures announced the close of its second flagship fund -- Stride Ventures India Fund II --at $200 million. The fund saw the first close back in August 2021. The second fund, like the first one, witnessed participation from leading banks, marquee family offices, corporate treasuries, sovereign funds, PE funds, insurance firms, and high net-worth individuals contributing to its success.

Stride Ventures' portfolio includes CredAvenue (Yubi), MyGlamm, Zepto, BluSmart, Uni, Upstox, WayCool, MensaBrands, MediBuddy, Wiz Freight, Perfios, Moneyview, VideoVerse, Chalo and Groyyo.

However, the venture debt is still under-penetrated in India. "It is less than 2 per cent of the venture capital inflows per annum, compared to 15 per cent in developed markets like the US, along with the growing startup ecosystem, which provides a huge opportunity for this asset class to grow further," added Sharma.

The venture debt funds in India raised $85 million in FY 2020-21, a steep rise from $62 million in FY 2019-20, according to a research firm, Venture Intelligence. In 2021, the global venture debt funding hit an all-time high of $58 billion -- a five-fold jump in the past eight years, according to data platform, Pitchbook.

The startups in need of cash had created a widening funding gap, said Pitchbook, in an another report. The startups found debt financing as a way to avoid more dilutive equity investment due to falling public market valuations, frozen IPO market and investor pullback from later-stage and pre-IPO startups.

Global private equity firms are also pushing themselves into the venture debt market. Blackstone has reportedly earmarked at least $2 billion for technology debt deals.

Byju Raveendran, founder and CEO of Byju's, was also in talks with various international and domestic banks in April to raise $400 million as a loan to fund 50 per cent of the $800 million (about Rs 6,000 crore) funding round of the ed-tech giant, said people familiar with the development. The move was part of the company's strategy to show the founder's confidence in the firm as he is leading the round and help shore up investor interest when the valuations are under global stress.

Raveendran is not the only tech entrepreneur who has raised loan to fund one’s own firm. In 2019, Japan-based banks, such as Nomura and Mizuho, were funding OYO Hotels and Homes' founder Ritesh Agarwal's $2 billion loan. 

Last December, mobility platform Ola raised $500 million via a Term Loan B (TLB) from marquee international institutional investors. The Bhavish Aggarwal-led Ola said the proposed loan issuance received a staggering response from investors, with interest and commitment of approximately $1.5 billion.