Debt implies borrowing, most commonly from banks, but also from other individuals and institutions. One of the most significant benefits of debt financing is that the company knows exactly how much money must be repaid and by when. This allows the organization to plan and prepare. Equity financing is the process of raising capital in exchange for a stake in a company. Since equity shareholders own the company, they have a claim to a portion of the profits, known as dividends. Dividends are taxed and are a cost to the corporation, as opposed to debt, where interest on the loan is tax deductible.
Volatility in the equity markets, as well as the inability of firms to achieve the target valuation in 2022, are making venture finance a more attractive alternative across the late and growth stages. According to recent statistics, venture debt as an asset class has been rapidly gaining prominence, with 29 deals worth $190 million in venture debt recorded during the first half of 2022, compared to 33 deals for $136 million in the same half-year in 2021 [1].
The rise in global interest rates is another major factor driving this trend. This causes a decrease in the current value of startup cash flows, which influences valuations. Publicly traded tech equities have fallen more than 50% from their highs and appear to be treading water. Because of these reasons, as well as financial uncertainties, many businesses are concerned about their cash runway [2].
Venture debt is appropriate for any startup that requires funds to meet working capital requirements, to grow and gain metrics to present to investors in preparation for equity fundraising, to finance acquisitions, or for companies that do not want to dilute stake but require funds to extend runways and reduce burns. Investors are also assured by debt financing because they are eligible for guaranteed returns on their investment through interest and redemption premiums. Such certainty does not exist in the case of equity financing.
The emergence of these debt platforms is also due to the introduction of India’s Insolvency and Bankruptcy Code, which provided creditors with important safeguards to ensure that Indian business owners would not go rogue. In conclusion, Indian enterprises are looking for alternative financing sources as a result of banks’ tougher lending restrictions, and thus, Private debt funds have seen a significant increase in the Indian debt landscape as a result of improved prospects.
[1] https://timesofindia.indiatimes.com/business/india-business/venture-debt-turns-favourable-as-equity-funding-dries-up/articleshow/91926306.cms
[2] https://www.moneycontrol.com/news/business/startup/rising-venture-debt-market-in-india-a-strategic-shift-or-a-short-term-frenzy-9241771.html
