Availability of debt funding at affordable rates remains a challenge for startups. Is it possible for financial institutions to lend to startups at 8-9% interest rates? On the panel this week are Sudhir Sethi, chairman of IDG Ventures, and Indifi Technologies CEO Alok Mittal.
For the motion
Sudhir Sethi, Chairman, IDG Ventures
I believe debt funding plays a very important role in a startup’s growth story. We have 70 companies in our portfolio which will need $140-150 million in debt capital in the next three years. This establishes the fact that there is a massive need for debt capital.
Venture debt is available but is typically very expensive because, though on the face of it, it is available at 14.5%, the actual cost comes to 17-18%. If I divide the companies into seed, early and late, seed will not get any debt because they are very high risk.
Companies at Series A and B are fits for equity investments. But companies at Series-C and onwards need a mix of debt and equity and these companies have a decent capacity to payback. The real need for debt capital comes at the stage when companies have achieved scale and are market leaders even though they may not be profitable yet.
For these companies which need large pools of growth capital, there is a very strong case for debt at lower rates, since what is being seen is that while companies are growing fast founders do not want to dilute too much.
If debt is available to large companies at lower rates and government policy allows housing loans at 8-9%, there is no reason why startups cannot get it at 10-11% since they generate 100 times more employment and can push up the growth gradient significantly for the economy.
Against the motion
Alok Mittal, CEO, Indifi Technologies
My view is that there is no doubt startups need debt at lower costs since debt is not dilutive and the cost of equity is much higher. But the major issue here is pricing. Lending to startups at 8-9% will simply not cover the risk concerned with startups.
For most banks, the marginal cost of lending is around 8%, which should cover both operational costs and risk of loss of capital. Home loans have a collateral behind the loans which the lender can liquidate to cover the principal amount. Also, home loans are lent for far longer duration than startup loans. Secured business loans are lent at rates upwards of 13-14%.
On the other hand, most startups would not have any collateral to offer. I think the problem of availability of capital is much stronger than the cost of capital. Most startups would be willing to get capital at 14% since equity is much more expensive.
While I agree that companies that are scaling up fast will need the right mix of debt and equity, I believe working capital kind of products can be a good substitute for venture debt funding since venture debt does not address working capital requirements. The nature of working capital financing products is that as the business grows the volume of debt also grows. Venture debt is a very different product.