Exploring debt as a funding option for Indian startups
Indian startups, which conventionally raise funds in equity, are increasingly warming up to debt funding. Typical private debt funders provide loans in the range of Rs.5–25 crore per transaction at an interest rate of 15–17%, while govt. and govt. supported institutions provide as low as Rs 1 crore per transaction with interest rates starting from 9% for startups. In this article, we speak to Divir Tiwari from Flick2know and Siddharth Shivkumar from Revive, two incubatee companies of CIIE which have recently raised debt fund for their ventures. Flick2know delivers QR code based marketing and distribution platform for corporates, while Revive provides an energy efficient, modular and a decentralised end to end e-waste management service.
Debt-fund: a strategic call for start-ups
Contrary to common perception, debt capital is seen as a cheaper source of funding by many entrepreneurs, who are reluctant to give away a large pie from their prized equity stake in a start-up that is well poised on a robust growth trajectory. Divir suggests that the interest rate bit can be deceptive — when one truly matches the cost of capital in the debt vs. equity structuring, the debt options available today are way cheaper more often than not.
Speaking of the options, we came across obvious names such as SIDBI, Trifecta Capital, SVB India Finance and Innoven Capital. Divir, who has recently raised debt fund for his startup Flick2know from SIDBI, goes on to add that getting recommended by renowned incubators, govt. agencies and other institutions bolsters the likelihood of the startup’s proposal being considered by the debt providers.
Both the entrepreneurs emphasize the need to do adequate due diligence before pursuing debt as a fund-raise option. Siddharth, for example, recounts from his recent experience of raising debt from SIDBI. Initially, they were hesitant about considering Revive, given the non-generic business model even though they had a revenue model in place. Revive took almost 1.5 years to raise debt from SIDBI under a scheme which is co-supported by DST for MSMEs with an interest rate of 5% per annum, although earlier they were considering to go with the Credit Guarantee Scheme.
The process of raising debt-fund: Demystified
Even startups that are actively looking for debt-funding opportunities, are often deterred by the lack of clarity on the process that entails it. Keeping this in mind we have summarized here the individual procedural experiences as shared with us by Divir and Siddharth. As any fund-raise endeavour, it must start with due investor diligence and scoping the ecosystem for any possibilities of recommendation for the startup that would boost its credibility to a prospective debt provider. Once a debt-fund institution gains an initial interest in a startup’s business model, the institution conducts a ‘preliminary enquiry’, which envisages sectoral classification, validating alignment with the institution’s mandate, etc.
This is followed by extensive documentation and filing as a part of due diligence by the debt funder. Once this process is complete to satisfaction, a third party agency (such as an incubator, NASSCOM, or an angel network) may be hired to validate the business model and ascertain technical soundness of the startup in its domain. On passing assessment by the third party, the startup is required to present before the disbursement committee which then sends a request for disbursement to the regional office. To accept the disbursement, the startup must open a ‘no-lien account’ with a bank.
As far as the criteria of selection is concerned, Divir mentions that unlike equity funders which look for startups with high growth trajectory, debt funders often seek a business that has minimum risk and proven financial performance. Siddharth adds, “debt-fund providers tend to prefer the ones with considerable market traction.” At the very least, there will be intensive scrutiny of last the three years financials, fine detailing of the projected financial model, and statutory compliance checks.
Advice for startups
Siddharth recommends pursuing debt funding while starting up as it will give confidence to the equity funding institutions. Also, the startup should always raise debt for Project Finance and go for equity funding when looking to raise capital for Marketing, Business Development, etc. He adds emphatically, “Go with formal financing institutions. Informal debt financing firms pose a much higher interest rate.”
“Patience is the key,” says Divir. One has to be clear why the fund is being raised with a clear utilization plan, and once the process commences, one has to patiently cooperate with the funding agency through the long-drawn process that debt funding entails. One also has to be ready for the extensive documentation and reporting that must be done during the life of the debt fund raised. “Lastly, a startup should only raise what it requires in debt, not a penny more, not a penny less,” he concludes.
