This article is originally written by Varun Gupta, Cofounder & Chief Investment Officer, Lend East
What constitutes an Early-Stage business?
According to Harvard Business Review (https://hbr.org/1983/05/the-five-stages-of-small-business- growth), every business goes through five stages of growth – from existence to resource maturity during their lifecycle. Each stage is characterized by an index of size, diversity and complexity and described by five management factors. At a very early stage, business needs to focus on designing and developing their product/service, building a customer base, and establishing a strong cashflow. This is also the phase when they face a unique set of challenges including finding right talent, gaining customers, and most importantly raising capital.
Getting into Fund Raising Mode
Raising funding is one of the most exciting and challenging times for an early-stage business. After the initial round of ‘bootstrapping’ and friends and family stage of financing, the business needs to make a choice of finding the right source of outside capital. It is important for any business to carefully consider their primary objectives before finalizing any outside funding. Timing plays a crucial role in every business decision and the same holds well for capital raising too. Fund raising should be a means towards the goal and not the goal itself.
Building the Capital Stack
Amongst the multiple factors, there are 4 key elements that needs a clear understanding and documentation as the business looks outside to build their capital stack:
- Purpose – why do you need to raise?
- Quantum – how much capital is required?
- Time Value – how quickly you need?
- Cost – both in cash and “kind”
Every business in general, and startups in particular should spend adequate time to map their requirements within the above mentioned framework. It is also advised to take professional help from outside if sufficient expertise/bandwidth is not available internally.
Type of Capital -Debt v/s Equity
Once the financing plan is crystallized, the business needs to make a choice on fund raising instrument. Both equity and debt routes could be suitable based on the requirements of the business plan.
Here is a brief comparison on both routes:
- Term: Equity capital is designed to meet longer term requirements and has a much larger gestation period. On the other hand, debt capital is deployed to fix short term issues like working capital gap, extension of cash runaway etc.
- Structure: Unlike equity investments, venture debt can take many forms ranging from term loans with monthly repayments to receivables financing credit lines to short-term working capital loans with bullet payments.
- Cost of Capital: In the longer run, on a fully diluted basis, the cost of equity capital is significantly higher than cost of debt capital. However, in the near term, servicing debt obligations can impact net cash flows for the business.
Why Consider Debt
Debt capital is a strong option for venture backed startups who want to add capital and minimize equity dilution. Venture loans can generally be arranged much more quickly than equity financings, saving valuable management time or meeting unforeseen needs. Further, a debt financing round does not establish a valuation for the company, which can be helpful ahead of a new round of equity financing, before a potential sale, or any other instances where management and existing investors would otherwise need to negotiate a price. Finally, venture lending firms do not generally require board seats or observation rights, removing questions of board dynamics. Debt is a finite obligation. In many cases, you can use debt in the same way, or as a substitute for, equity, without the long- term dilution of equity.
Venture Debt Use Cases
| Working Capital Management | Finance negative working capital that gets blocked in inventory. The inventory days could range from 30 to 180 days across different vendors
creating significant liquidity gap. |
| Account Receivables
Financing |
Future cashflows (against confirmed receivables) could be advanced early
which allows for unlocking of capital for new orders. |
| Recurring Revenue
based Financing |
Financing based on future recurring revenue streams and the future
earnings they are expected to bring in. |
| Onward Lending | Loan book building finance for fintech companies |
| Runway Extension | Non-dilutive finance to extend cash runaway of a business before its next
equity round |
| Capex/Project
Financing |
Optimize cost of project by leveraging equity to raise debt |
| Acquisition Financing | Fund inorganic growth by using leveraged capital instead of only equity |
| Favourable Tax
Treatment |
Useful for companies with Holdco/Opco model in multiple geographies to
avoid withholding tax expenses |
Early-Stage Debt Funding Players in SEA
In SEA, venture/early-stage debt is fast emerging as an alternative and complimentary source of financing for high-growth companies that could only raise equity capital in the past. Though still in its early days, the region has seen emergence of several companies operating in this space over the last 5 years. Some of the notable names include Lend East, Helicap, Genesis, Innoven SEA amongst others. Each of these companies are focused on providing venture debt solutions across single/multiple use cases as discussed above.
Noteworthy Transactions in 2022
| Venture | Country | Debt Capital Provider | Sector | Link |
| Akulaku | Indonesia | Lend East | Fintech | https://e27.co/akulaku-raises-us10m-in-debt- funding-from-lend-east-to-further-build- lending-portfolio-20220330/ |
| Erudifi | Singapore | Helicap | Edtech | https://www.techinasia.com/edfintech-firm- erudifi-nets-15m-debt-facility-helicap |
| Hangry | Indonesia | Genesis | Foodtech | https://www.techinasia.com/hangry-series-a- |
| Dat Bike | Vietnam | Innoven SEA | EV | https://www.dealstreetasia.com/stories/dat- |
Mainstream Option
As the venture ecosystem gets matured in the region, debt financing is going to emerge as a viable mainstream option for any early-stage business. Debt makes for a disciplined option if there is a reasonable certainty in the cashflows and a maturity in the business behaviour.
About Author
Varun Gupta is the Cofounder and Chief Investment Officer of Lend East – Singapore based alternate debt fund focussed on providing tech driven, non-dilutive growth capital to technology ventures across South-East Asia. Till date, we have successfully deployed around USD 50 MM of debt capital into some of the most promising early-stage companies in the region.
Varun has 16+ years of financial services experience across ASEAN and India. Over the last 8 years, he has been instrumental in building and scaling up a couple of fintech businesses in the SEA region. He spent first 8 years of his career in large traditional banks/non-banks in India where he specialized in structured credit investments.
