Featured ArticleIssueOct 21

Debt, a powerful tool to manage working capital outlay

Best practices advice from organisations that have a strong track record of success in managing their venture capital programme. Abhinav Suri, Partner, Strides Ventures shares an insight

While looking for growth capital, a lot of successful new-age businesses are increasingly taking a round of venture debt along with equity or in between equity rounds. The size of debt varies depending on the business model and maturity of the businesses and is typically 5-20 per cent of the total capital raised for new-age businesses that are yet to achieve profitability.

Venture debt can be effectively used with the following objectives in mind:
• Protecting equity dilution
• Extending runway between rounds
• Financing working capital mismatch
• Financing capital expenditure and
acquisitions
• Create a credit track record

The repayment structure of the debt should ideally correspond to the enduser objective in mind. An amortising term debt structure can be used for instance to extend the runway and reach a certain operational benchmark viz. revenues, several customers etc. and then raise an equity round at the desired valuation. A revolver debt structure can be used effectively to finance working capital viz. inventory, receivables. The revolvers continue as long as there is working capital and can be continuously financed through debt. This also creates a successful credit track record and can help in future debt raise from cheaper sources like commercial banks as the business matures and achieves profitability.

Future cash flows protected by contracts with a high degree of certainty, can be a good debt use case and appropriate debt structures can be built around the same. Debt has been a powerful tool for many B2B companies in managing their working capital outlay. For example, startups working with hospitals have realised that hospitals prefer to pay over some time for their use of consumables, surgical, diagnostics etc and such working capital is effectively plugged through debt. Similarly, medical device distributors have realised the potential for debt to build inventory and provide end financing to their customers. Debt has also been used by such medical equipment providers and hospitals for the purchase of high-value equipment and machines.

The venture debt raised is typically secured by all the business assets of the company without any onerous need for collateral or personal guarantees, and also carries a warrant component in addition to the interest cost. It is important for founders to time the debt round appropriately, after the business model has been proven, operations have scaled with a positive contribution margin and there is adequate equity capital. Raising debt too early or in excess can put undue stress on the balance sheet and can be counterproductive. As a thumb rule, cash flows with a high degree of predictability are best financed through debt.

The Indian startup ecosystem has come of age over the last few years across several sectors including healthcare which has seen considerable acceleration due to the pandemic. Venture debt as an asset class has also gained significant ground in light of this and will continue to grow as businesses scale. Founders should use this source of growth capital judiciously and save dilution.

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