Why the venture capital debt market is bubbling

India’s venture debt funds raised $85m in FY21, up from $62m in FY20, according to Venture Intelligence Illustration: Chaitanya Dinesh Surpur

AAs the macroeconomic environment deteriorates and venture capitalists slow their pace of issuing checks, startups have turned to subprime lenders who provide debt financing. “We used to do one deal in 10 before. Now we evaluate 20-30 companies before we do a deal,” says Apoorva Sharma of Stride Ventures, one of the top six equity debt providers. -risk in the Indian market. Last year, the New Delhi-based company deployed Rs 1,100 crore (around $134 million) across 60 deals. This year, the figure is already Rs 1,300 crore (159 million) until September.

In fact, the amount of debt disbursed through venture capital debt in India doubled in 2021 to $538 million from $271 million in 2019, according to the Venture Capital Debt Report 2022. venture in India from Stride Ventures. One hundred and eleven companies took on venture capital debt, including Mensa Brands, Urban Company and Licious, with notes ranging from $2 million to $25 million.

According to Venture Intelligence, a data provider, the first six months of 2022 have already seen startups attract $289 million in venture debt funding. But that’s “pretty low,” according to Ashish Sharma, managing partner of Innoven Capital, because several deals go unreported. He believes that this year, the total amount of venture capital debt funding disbursed to Indian startups, especially those in growth and later stages, may exceed $1 billion.

“The deal flow is hectic,” he says. The drying up of stock markets is a key factor in the increase in demand. Startups aren’t able to attract the same kind of funding that they could before, and if they are, they’re not achieving the desired valuations. This is especially true for growing and late-stage startups. Take the case of MobiKwik. The digital payments provider raised Rs35 crore in venture capital debt from BlackSoil in August, amid a delay in its initial public offering (IPO). This came more than 12 months after it filed its draft Red Herring prospectus with the Securities and Exchange Board of India (Sebi).

Falling public market valuations, lackluster IPO markets and investor pushback have prompted startups to resort to debt financing to avoid diluting equity while meeting business goals, says Sharma of Innoven.

“Venture capital debt helps provide that runway for cash-strapped startups until market conditions improve,” says Sanjay Mehta, founder of 100X.VC, a funder of startups in startup. They can then raise funds on a more solid basis, at better valuations.

Although the subprime debt market is currently booming, it has actually seen a recovery over the past three to four years. This for more structural reasons.

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First, the ecosystem is more mature and the founders more aware. “The education of founders has been multiplied by many,” says Ankur Bansal of BlackSoil. They now better understand the nuances of debt and how it can help them achieve their business goals and strategy, he says. Use cases for venture capital debt include not only increasing a startup’s runway given the uncertain funding environment, but also helping meet working capital needs, supply chain needs or financing mergers and acquisitions. “Often when equity funding dries up, big players use it as a strategic opportunity to recruit smaller players. Venture capital debt is a great option for this rather than taking equity and diluting your stake,” says Stride’s Sharma. Last year, for example, was a big year for Thrasio-style companies like Mensa, Global Bees, and Upscalio. “Acquisition was a key part of their business models and s ‘getting into debt made sense,’ she says. Similarly, D2C beauty brand MyGlamm has raised Rs155 crore in venture capital debt from Trifecta Capital and Stride Ventures to fund a slew of content and media acquisitions. social media.

Second, the size of the market has increased. Traditional venture capital funding has grown from around $13 billion in 2019 to $35 billion in 2021, according to Venture Intelligence. “Venture debt is a derivative asset class, which means it usually follows venture capital funding,” says Innoven’s Sharma. “So as the venture capital market grew, so did the venture debt market. It’s a natural progression.

Third, the supply of venture capital debt has increased with the flow of money to companies. India’s venture debt funds raised $85m in FY21, up from $62m in FY20, according to Venture Intelligence. Stride, for example, announced the final close of its second flagship fund at $200 million (Rs1,600 crore) in August, surpassing its target corpus. At the time, the financier noted that he had seen participation from leading banks, reputable family offices, corporate treasuries, sovereign wealth funds, private equity funds, insurance companies and HNI, without specifically naming LP (limited partners). Note sizes are expected to increase from $2-3 million in the first fund to $4-5 million (Rs30 crore to Rs40 crore) with this fund.

“Over the past three years, we have seen a lot of interest from domestic investors. Previously, it was very niche. Now we are seeing family offices and even founders with cash flowing money into venture capital debt,” says Sharma of Innoven.

Despite increased demand, venture debt financiers are cautiously optimistic. “It’s not when a startup fails to raise equity that it can raise debt,” says Bansal. “The review is tight, as is the emphasis on unit economics.”

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Stride’s Sharma also notes that levels of scrutiny and due diligence have, in fact, increased. “Our conversion rates are lower now. We take more time to finalize the companies we want to support,” she says, adding that the basic filters include a minimum of $4 million in equity raised by the startup, at least Rs2 crore in monthly revenue and a positive unit economy.

Despite its growth, subprime debt remains a small slice of the overall market. “India’s venture debt market is very underpenetrated. It accounts for less than 2% of venture capital inflows per year, compared to 15% in the US,” says Stride’s Sharma. This means that the growth opportunity is huge and the momentum is not expected to slow down. Said Sharma of Innoven, “There’s no turning back from here. We’re going for a ride.”