Startups use venture capital debt to build a sustainable business
DUBAI: Venture capital debt is in demand and startups around the world, especially in the region, have started to consider this option to raise funds to facilitate business and protect equity, Khaleej weather reported.
Risk debt is a loan to companies that have raised funds from venture capital investors. Traditionally, banks only lend money to companies that have collateral; Debt at risk is different in that lenders will offer debt financing to promising companies that are not positive in terms of cash flow, without existing collateral, provided that these emerging companies have raised funds from VC and have strong growth potential, says Jon Levy, CEO of Y. Combinator, which provides seed funding for startups.
The risk-debt model originated in Silicon Valley in the 1970s and has since grown into an established form of alternative capital available to venture-backed companies around the world.
Many well-known tech companies have taken on venture capital debt at some point in their growth journeys, including Google, Facebook, Uber, Airbnb and Dropbox, according to a PWC report titled Venture Debt: The New Growth Mantra For startups in Southeast Asia.
“Mainly, the founders [and other shareholders] High-growth, cash-hungry startups want to avoid excessive and avoidable dilution in the early stages of raising capital when valuations are typically low.
Founders stand to lose on richer valuations at a later stage of exit options when the company reaches its full potential and has the capacity to attract millions more.
The attraction of debt is therefore understandable. However, it is difficult to access financing from traditional banks given various constraints, ”the report says.
Saurabh Gupta, co-founder and board member of Vistas Media Acquisition Company, says risky debt is increasingly becoming a popular funding mechanism within the ecosystem of startups in emerging markets such as Mena and Asia.
Startups with clear operating plans and strategies, which can demonstrate the efficient deployment of funds with reliable income streams backed by strong management teams, can maximize their growth trajectory with the use of risky debt. without diluting their equity in the early stages.
“This is something that local banks cannot compete with because traditional lending has many constraints compared to VCs. However, this presents a new business opportunity for local banks in the Mena region to assess the deployment, like what DBS Bank in Singapore did jointly with Temasek, launching a $ 600 million debt financing program in July. .
With the growth of tech startups in the MENA region over the past five to six years and now with PSPCs providing an exit mechanism, the demand and investment appetite for risky debt is increasing rapidly in the region.
Gupta says a large number of venture capital firms are now offering risky debt to high-growth startups with predictable revenue growth and a controlled rate of utilization.
“Risk debt investors additionally rely on the company’s ability to raise equity capital at a later stage and fully or partially repay risk debt investors. If the startup can offer solid guarantees [intangible assets] within the company itself, like patents or IPs, that’s an added bonus.
“They also get upside potential in the form of warrants or large discounts when converting into shares with a predetermined valuation cap when certain valuation milestones are reached. A win-win for investors and startups, ”he added.
The trend is certainly emerging in the region. For example, YAS Investment and Liquidity Capital jointly launched a $ 100 million risk debt fund to support Mena’s tech startups, PFG structures launched a risk debt transaction for Dubai-based Trukker and the platform. -Buy Now-Pay Later Tabby has raised $ 50 million in debt financing from a San Francisco-based company.
Startups such as Trella, Trukker and Tamara are some of the regional startups that have raised a significant amount of debt in the past six months.
Walid Mansour, a Dubai-based venture capitalist, said: “Venture debt is a must-have product in the MENA region as it has proven to be an established product in Western markets. The concept helps startups grow, which has potential for income and growth, as debt is a cheaper and more efficient option than expensive equity. The region certainly needs more effective risk debt instruments.
Swethal Kumar, CEO of Startupscale360 and co-founder of The Crossroads, said: “While fundraising from venture capital is important for early stage startups, they need to be careful not to dilute them too quickly. large capital at an early stage. Sometimes venture capital debt helps lengthen a startup’s trail and reach certain milestones without diluting equity. “
“It’s like a safety net that acts as a buffer against certain risks. As we know that debt is cheaper than equity, it helps to increase the valuation of the company. But getting debt from commercial banks for startups is sometimes difficult, and even if you press down on debt, the bank’s compliance is usually horrible. “
Kumar says risky debt funds generally provide more flexible capital with fewer covenants. “During a pandemic, when venture capitalists weren’t sure whether to invest in new deals or bail out their affected existing investments, capital-hungry startups turned to venture capital debt at the global scale. “
However, Biancka Gracias, partner at Iclo, warns: “I am very skeptical of the effectiveness of venture capital debt for startups in the region due to the nature of startups and the fact that they hold more classes of intangible assets than tangible.
“The spending and structure of risky debt also remains unexplored. As a legal mind, this should not be considered by startups as it will drag startups into a senior debt hole that might not be favorable to their balance sheets for potential future investors.