Venture Debt vs Venture Capital: Which Path Should Entrepreneurs Take?

As we inch closer to 2025, we'd like to thank you for being part of our 2024 RizingTV journey. And to celebrate a new inspired year, we're excited to announce that we're unlocking the vault to share some of our premium articles for free!

It seems like over the years, there's a financial instrument quietly gaining traction amongst growth-stage companies in India: venture debt. It may be considered an alternative funding mechanism offering loans and once a niche, it could?be emerging as a tool for companies seeking capital without wanting to relinquish too much equity.

So, what's driving interest? What's making venture debt gain popularity as an asset class??According to Dr Somdutta Singh, Serial Entrepreneur, Founder and CEO - Assiduus Global Inc, LP Angel Investor, Advisor Govt of India (Core Committee Member of WEP - Niti Aayog),?"The interest is being driven by the relative safety of debt instruments compared to equity, steady income from interest payments and potential equity upside. Additionally, as the startup ecosystem is maturing, I am certain venture debt might become a valuable option for startups looking to complement their capital structure".?

"India's surge in startup activity, over the last few years in particular, presents both opportunities and challenges for the venture debt market. Opportunities lie in providing growth capital to promising startups, while challenges include assessing risk and managing defaults. Education, the people involved, standardizing terms & collaboration between lenders, startups and investors can address these challenges", adds Singh.

But, while there may be an allure towards VC due to its potential for high returns, how does the return profile of venture debt compare??"While venture capital entails equity ownership and the potential for substantial returns through exits, venture debt involves providing loans to startups with fixed interest payments. The return profile of venture debt is typically more predictable, with steady income from interest payments and potential equity kickers, but it may not yield the astronomical returns associated with successful equity investments in venture capital", Singh states.

What about performance metrics? Are the ones used for evaluating venture debt investments different from what may be used for VC??Singh remarks, "In venture debt, metrics often focus on the startup's ability to generate sufficient cash flow to meet debt obligations, whereas venture capital metrics may emphasize growth, market share and exit potential. KPIs in venture debt could include revenue, cash runway and debt service coverage ratios".

And are family offices increasingly exploring alternative investments, like venture debt? "Family offices are... attracted to the steady income, lower risk compared to equity and potential equity upside offered by venture debt. The diversification of their investment portfolio and the desire for consistent returns are key drivers of FOs' interest in this asset class", opines Singh.

So, what should startup founders do? It could be hard for them to discern whether to go for the VC route or the venture debt route. Some might believe in a mix of equity and debt financing. Is there a balance to be struck between the two for startups to optimize capital structure??According to Singh,?"If rapid growth and scalability are your primary goals, VC funding may be suitable. However, for startups seeking non-dilutive capital with predictable repayment structures, venture debt could be a viable option. Striking a balance between equity and debt financing depends on the startup's specific needs, growth trajectory and risk tolerance."

And what could 2024 look like for venture debt? "I can see collaborative models between banks, NBFCs and venture debt funds emerging, providing a more diverse range of financing options. Investors and startup founders should stay attuned to evolving terms, interest rates and risk mitigation strategies in the venture debt landscape. The importance of a robust due diligence process and clear communication between all stakeholders is as always crucial for successful venture debt transactions" prophesies Singh.

"Traditionally, technology, healthcare and consumer goods sectors tend to attract venture debt, but it depends on the risk appetite of lenders and the growth potential of startups in specific industries", quips Singh.

(Become a paying subscriber of RizingTV to get access for other premium content.)