Say you’ve built a business. You’ve hired a great staff, built a great product, and your users love what you’ve made. To make sure your business survives in a cutthroat startup environment, you might need to bank on being able to expand faster than your competitor. But that takes money—often lots of it.
You can seek out venture capital. But there is another option too: venture debt.
For this week’s “Venture Voices,” the writers of KrASIA spoke with four investors who unpacked what this form of debt financing entails, and what impact it may hold for companies who utilize it.
Martin Tang of Singapore’s Genesis Alternative Ventures provided some background on what venture debt is:
Venture debt was a very new asset class [in Southeast Asia] back in 2015. However, if one looks at Silicon Valley, Europe, and India, it is a very mature asset class. Venture debt allows startups to raise additional capital at a lower dilution than pure equity. As startups grow from Series A onward, having a fundraising strategy that includes venture debt will allow founders to retain a higher stake in their company. I believe that venture debt creates a capital efficiency that is win-win for both the VC investor and startup. Equity should never be used to fund working capital or pay for inventory.
Venture debt can be an alternative solution for a company to purchase inventory for manufacturing products or trading purposes.
Tang also provided an example of how venture debt works:
Here’s a use case: An IoT company needs to pay a contract manufacturer upfront to produce units of its IoT device, which will then be sold or rented to customers. However, the repayment cycle is long and as the IoT company grows, a working capital gap is created. It would be extremely dilutive to continue to fund the working capital through equity so venture debt can be used here to fund an inventory purchase.
Also speaking in Singapore, Paul Christopher Ong from InnoVen Capital outlined a few situations where venture debt applies:
Taking a venture loan provides additional but less dilutive capital to help a company add more fuel to the fire and to grow even faster, or to give a company a longer runway. Hence, it can be applied to most business models in which the growth levers are identified, such as opening new brick-and-mortar shops quicker, additional marketing spending, new product development, buying more inventory, or locking down a greater supply of assets and services. It can also be applied as a working capital solution, like freeing up trapped cash that arise from long payment cycles. Examples of our portfolio companies that have benefited from obtaining a venture loan include Tiki and Fave.
Speaking from his own experience as an entrepreneur and investor in Vietnam, Justin Nguyen of Monk’s Hill Ventures told KrASIA about how venture debt can be utilized by a business seeking funding:
Some notable VCs have sided against venture debt early on. Having taken on venture debt as a former founder myself, I definitely see the appeal and venture debt should be considered when available.
My rule of thumb is to only consider venture debt for opportunities that can potentially accelerate the business but at the same time would not impact the core of the business. Some examples include testing a new market or serving as a buffer (or bridge) as you’re spending above plan, because a startup’s growth backed by venture is also above plan. The other side, of course, is to not take venture debt to finance your core operations—that’s the role of equity financing.
Nguyen also spelled out the pitfalls:
At the end of the day, the allure of venture debt is understandable—cash with much less dilution than a pure equity raise—but founders need to understand and manage the risks of using venture debt.
Specifically, venture debt is considered senior debt, which in a legal agreement can be very potent. Venture debt will generally take priority in the pecking order of investors. Founders should be aware of potential consequences in situations where the interests of venture debt may take priority over the interests of the founder, their employees, and their equity investors.
Also in Vietnam, Hoang Duc Trung of VinaCaptial Ventures echoed those sentiments:
The downside to venture debt can be catastrophic. If the company cannot fulfil its commitments on the repayment terms or covenants, the lenders can call the loan and take extreme litigation actions or even force the company into liquidation. Venture debt can also create problems in later equity rounds, where new investors will have to agree to either repay the debt or invest below the debt in order of preference. Both situations are difficult for new investors to accept when they seek to inject money directly into the operation.
Hoang spelled out when he feels venture debt should be avoided, as well as when it works:
Hence, the common advice is not to raise capital through venture debt if companies don’t already have assurance or solid means for capital access. However, venture debt is perfect for companies in fast growth phases, when they have eliminated the concept risk and found a product-market fit.
Martin Tang is a co-founder and partner at Genesis Alternative Ventures. Tang co-founded Genesis in 2018 with two other partners after having spent more than ten years in banking. Genesis Alternative Ventures is a Singapore-based private venture lending firm, targeting Southeast Asian startups that are looking to raise money while minimizing stake dilution. In May 2019, Genesis teamed up with Indonesian bank CIMB Niaga to build a venture debt program worth USD 20.7 million specifically to finance Indonesian startups.
Paul Christopher Ong is an associate director at InnoVen Capital, where he is responsible for sourcing, evaluating, and executing venture debt transactions in Singapore and Southeast Asia. InnoVen Capital recently closed an additional USD 200 million to provide venture debt throughout Southeast Asia, India, and China.
Justin Nguyen is a partner at Monk’s Hill Ventures in Vietnam. He is an entrepreneur, investor, and engineer who has had instrumental roles in four startups in Silicon Valley, Shanghai, and Vietnam.
Hoang Duc Trung is the deputy managing director of VinaCapital Ventures, which is a USD 100 million Vietnam-focused venture capital platform that invests in the next generation of Southeast Asian startups. Before that, he spent 13 years as senior director of DFJ VinaCapital L.P., where he developed and looked after a Vietnam-related portfolio covering ICT investments in Southeast Asia.
This article is part of “Venture Voices,” a series where the writers of KrASIA speak with venture capitalists based in Southeast Asia to get their takes on topics of interest.