In the past few months, the level of inbound enquiries Genesis has received for venture debt has increased by 30%. This has been the case too for other venture lenders across tech ecosystems where venture debt is an established asset class. In a parallel world, large corporates, as well as PE-backed companies, have been drawing down on available credit lines as an insurance buffer.

Please read part I: Venture Debt – Panacea or Poison – for tech-backed companies during Covid-19

There are many reasons for the increase in venture debt enquiries:

• Venture debt for runway extension/insurance buffer: Venture debt can help a company to extend cash runway with lower dilution; Savvy VC investors and founders realise the wisdom in bolstering the balance sheet in times like these. It is better to have venture debt and not need it than to need it and not have it.
• Venture debt as part of funding to avoid a downround: With COVID-19 decimating business plans, founders realise the need to raise capital in a form that delays the valuation benchmarking – raising venture debt / convertible rounds can help the company buy time as it adjusts to disruptions caused by the pandemic.
• The colour of cash is the same: Founders not knowing the difference between equity and debt. They knock on both doors hoping that one would open.

So when can venture debt be a panacea to startups in COVID-19?

1. Extension of cash runway

The pace of VC investments may slow down during a crisis, it will not stop. Good tech companies will still be able to raise VC money. With the equity cash, these companies can then extend its cash runway with some venture debt. 

Related Article : Deal Structure for Venture Debt Success

Notwithstanding the current crisis, startups with a viable model and differentiated offering continue to attract equity funding. 

In the US, there continues to be high profile funding rounds being announced.

• Payment gateway, Stripe raised a US$600m Series G at a US$36bn valuation; 
• Online brokerage Robinhood Markets Inc raised US$280m led by Sequoia Capital valuing it at US$8.3bn

Closer to home, we are seeing green shoots of larger than usual funding rounds being completed than pre-crisis :

• Dathena raising a US$12m Series A round;
• Kopi Kenangan raising a US$109m Series B round; 
• Kargo, an Indonesian based logistics company raised a US$31m Series A;
• Ninjavan raised a massive US$279m Series D funding round;
• Indonesian consumer goods mall GudangAda raised US$25.4m in a Series A round led by Sequoia India and AlphaJWC;
• Philippines media startup Kumu raised a US$5m Series A; 
• Thai venture builder RISE raised US$8m in seed funding

A strong equity raise combined with a right proportion of venture debt, will help a startup to extend its cash runway at a lower dilution than a full equity raise. The cash runway extension will allow companies to grow further before the next equity raise – this will potentially allow it to raise equity at a higher valuation, again leading to lowered dilution.

2. Bolstering balance sheet as insurance buffer

• For companies that have a reasonable amount of cash on their balance sheet, venture debt is a viable way to further boost that cash as an insurance against a protracted downturn.
• In the US, AirBnb managed to raise US$2bn in equity and debt over two separate transactions in April. 

In the case of AirBnb, it raised US$2bn in equity and debt in two separate transactions despite having US$3bn of cash on its balance sheet. It was notable that funders were large private equity groups. Media reports of the deal terms and structure suggests that the funding was structured similar to how a venture debt deal could have been done. 

Had AirBnb raised the same amount of funds via a sale of shares, it would have resulted in higher equity dilution, longer execution timelines and crystallisation of a lower valuation meaning that later investors would lose money.

3. Avoiding crystallising a down round:

• Companies whose business plans have been affected by COVID-19, i.e. will not be able to achieve milestones prior to next equity raise, can use a mix of internal equity funding (usually in the form of a Convertible Note) and venture debt to extend cash runway.
• This combination provides the company with much needed cash runway extension and yet avoids setting a valuation benchmark. However, it means that the company has to get things right this time.
  • The comfort is that many successful startups have experienced such situations before and gone on to increase valuation by multiples thereafter

Related Article : Venture Debt Market Reaches All-Time High According to Largest Study Ever

Venture debt, if not used under the right circumstances, can be poison.

1. Venture debt as a funding of last resort

We have seen many companies come to Genesis because they have exhausted other avenues of capital sources- whether they be VC money or loans. Venture debt cannot be used as funding of last resort as this is akin to taking equity risks, with a capped return.

2. Venture debt as a source of cheap funding

The other reason for increased enquiries is due to misconception that with global interest rates at rock bottom, venture debt rates must be low as well. On the contrary, most startups are now deemed to be higher risk due to the economic disruption brought about by COVID-19. Therefore, on a risk adjusted basis, venture debt rates have remained  flat or slightly higher than pre-COVID-19.

Genesis’ approach to venture debt in COVID-19

COVID-19 has not changed how we fundamentally assess each deal. Despite the increase in venture debt enquiries, deployment of capital is reserved for borrowers that demonstrate the following characteristics:

1. Sustainable business plan with proven revenues and positive unit economics 
2. Founders with demonstrable leadership and management experience
3. Backing and guidance by Tier 1 VCs
4. Cash runway of at least 12 months

Venture debt is not without its risks, however a well structured transaction can help high quality companies to extend their cash runway to tide through tough times.

At this time of writing, numerous countries and cities remain in lockdowns of varying degrees with shops, businesses and schools staying closed. The inconveniences this has brought to daily life/businesses are well documented. I want to share some of my observations on the positives that the lockdown has brought about.

In these unprecedented times, humans have demonstrated the ability to react quickly to the new environment – the speed at which COVID-19 changed the way things were done was breathtaking. 

Online-everything. Online services given by religious organisations, online motivational sessions, online ministerial meetings, large scale online press conferences and interviews, online marathon races, online workout groups, online clubbing, online house parties…the list goes on.

New words for the old economy. WFH, e-sign, Paynow, Home delivery, contactless delivery, Zoom Meeting, Teams, Google Hangouts, Whatsapp call, House Party etc. have become de rigueur. 

Pivoting. Garment and car manufacturers switching to producing face masks, microbreweries and gin distilleries producing hand sanitiser, Vacuum cleaner factory line producing ventilators, Luxury hotels becoming quarantine centres. 

Related Article : Venture Debt for tech-backed companies during Covid-19

Reimagining work. I had the privilege of conducting a session of the inaugural online career fair of a local university last month over Zoom. We had more than 50 attendees dialling in from their respective homes/offices. Prospective interns watched their screens, listening to what was being shared. They were actively raising hands virtually and asking questions via the chat function. That people felt safe, physically and metaphorically, to ask questions was a big win. All in all, we had an extremely successful career fair with high engagement levels and applications. It is not inconceivable that with video technology / online KYC, workers getting hired without having to physically see a hiring manager prior becomes more prevalent.

Humans have gone through disasters much worse than COVID-19 and thrived. What makes me hopeful is that we have more advanced science and technology at our disposal now than ever before. I am of the firm belief that we will get through and thrive in the same fashion.

“This too shall pass”. The current lockdown is an opportunity to catch up on things that matter and make us better people. Eventually, activities will return to a semblance of normality. The question then would be, ”Did we make use of the lockdown to position ourselves for a rebound?” This could be learning a new skill, pivoting a product to suit social distancing measures, refining workflow processes etc.  

At Genesis, we are making full use of this time to do the following:

1. Housekeeping / Refining internal SOPs
2. Continued engagement with our portfolio companies with a view to supporting them / exploring new business opportunities / making new introductions to them
3. Active outreach to LPs both existing and potential to update them on investment portfolio, what new deals and trends we are seeing 
4. Talking to our VC Partners to update them on portfolio companies as well as exchange notes and dealflow
5. Engaging with ecosystem partners to explore collaboration opportunities that we never had the chance to do so pre-lockdown – they could be webinars, industry thought pieces, mutual introductions etc.

We did not choose for COVID-19 to come disrupt our lives, but we certainly can choose what we want to do with our lives / businesses while we go through this period.

Stay strong and stay healthy.

Great companies that take venture debt often share several characteristics – solid business fundamentals with strong unit economics; a clear understanding of who the customer is; remarkable founders and leadership teams that execute well; and more often than not, top-tier equity sponsors that bring invaluable investing experiences with them.

A solid Deal Structure plays a vital role in Venture Debt success.

When companies think about raising venture debt, they often think about getting the lowest interest rate. However, there are other critical elements in a venture debt deal that are perhaps not as obvious and the venture debt deal structure is certainly one of them. 

Like any well-built house, it is important to have a sound structure. A sound deal structure is no different. The optimal venture debt deal structure not only plays an important role in helping companies maximise their cashflow potential, but it also ensures alignment of interest between the lender and the borrower and serves as a foundation to help companies raise new equity rounds in the future at higher valuations. As Warren Buffett reminds us, “Only when the tide goes out that you learn who has been swimming naked.” Poor structuring could have a trickle-down effect that could hinder companies’ ability to repay which in turn becomes an obstacle to future equity raises. 

Questions for every startup

Now I know you’re asking, “So what’s the most ideal venture debt deal structure?” First, we seek to understand what the debt is really being raised for (e.g. to fund working capital, growth expansion, refinance, acquisition)? Second, what is the real cash runway in the different growth scenarios? Third, how might a downturn (as we are experiencing now) affect the ability to repay? 

Related Article : The Venture Debt Investors Journey in Southeast Asia

Depending on the answer to these (and many other) questions, we think about the kind of debt structure that would suit the needs of these companies. It can be an amortising term loan with a 2 to 3 year repayment period; a revolving line of credit (or revolvers); or even revenue-based financing where debt repayments are tied directly to the company’s revenues. No two businesses are the same, and so no two deal structures should be the same either.

Amortising Term Loan

What if a company wants to use venture debt to fund expansion, buy equipment or acquire another target company? For these longer-term assets, they should ideally be financed with longer-term liabilities such as term loans. The company borrows, say US$1m today, and pays a combination of principal and interest over the term of the loan with the entire amount being repaid by maturity. The exact terms will also vary from company to company depending on their risk profile. 

Revolving Line of Credit

A revolving line of credit helps to smooth out fluctuations in working capital that seasonality or delayed invoice payments can cause. For instance, an eCommerce retailer wants to fund a seasonal inventory build-up between September to December for Christmas sales. This creates a need to fund the increase in inventory and account receivables. 

Related Article: Launch of Southeast Asia Independent Venture Debt Financing Business

A revolver will be most useful in this scenario to cover for the company’s short-term operational cashflow needs. Unlike a term loan, the borrowings are repaid once the account receivables from the sales peak are collected, for example 60 days later.

Revenue-based Financing

This form of financing is mostly suitable for companies with high gross margins and subscription-based revenue models (such as SaaS). With a meaningful traction from the monthly recurring revenue and low churn, monthly repayments will be based on a certain percentage of the monthly top line revenue. 

If you like to explore raising venture debt as part of your overall capital needs, drop us a note and we will work with you to understand your needs. 

The first quarter of 2020 whizzed by so quickly. In continuation to my previous post, let’s dive into what a founder should look at when considering venture debt. First up, venture debt is not convertible debt. I still get asked a lot if we can do convertible financing. The straight answer is no. Venture debt is a form of debt investment that augments a portion of the equity need. It also provides a funding mix shift for equity-sponsored start-ups who are raising early growth capital here in Southeast Asia.

Clever mix of venture equity and debt capital markets

Most startups have negative working capital and operate in a dynamic and uncertain environment. Even more so in today’s climate. As a founder who is embarking on a fundraising plan and doing an extensive financial modeling exercise, the appropriate question to ask should be (1) do you raise 100% of what you need, or (2) 100% plus some extra buffer? Let’s take the current Covid situation to illustrate the financing conundrum. If a founder had raised adequate funds without any buffer, the unforeseen decline in business could put the company in a precarious situation and financing dilemma. Reducing the opex is one way of extending the runway, or raising some cash buffer initially could have helped cushion some of the impact. 

How much debt should a founder seek to raise

Assuming a founder needs $x million of capital to take the business to the next value inflexion point. The founder now has an option of raising $x + $y million where y is the venture debt amount and x represents the equity portion. Some founders opt to raise $x – $y million where the difference is the equity portion. This alternative allows the founder to minimize equity dilution and this stems from the venture lender entitlement to some option rights as part of the transaction. Venture lenders also typically limit average equity to debt ratio of 3:1 to avoid an overleveraged situation.

Read More : The Venture Debt Investors Journey in Southeast Asia

Highlights of venture debt transaction

There are several key terms in a venture debt capital markets transaction, with reference to deals here in Southeast Asia. Interest rates are typically in the low-teens and venture lenders would ask for a small fraction of equity (<2%) as a warrant option. These terms would be risk-adjusted based on parameters such as the stage of the company (e.g. Series B vs Series A), quality of equity sponsor, and country of operations etc. Depending on the quantum, there are commitment and legal fees involved which may be upwards of 1.5%.

A start-up’s perspective of venture debt

Horangi Cybersecurity was Genesis’ 1st venture debt portfolio and just recently in March 2020, the company announced it has completed a Series B round (https://www.horangi.com/blog/horangi-raises-us20m-to-strengthen-cyber-security-offering-in-southeast-asia). Kevin Lee, Executive Chairman, Horangi Cybersecurity shares his experience with venture debt. As a leading cybersecurity company in South East Asia, Horangi is growing and expanding fast. Kevin highlighted the challenges faced by a young startup and said “our working capital needs are growing even faster, as we need to spend up front to acquire customers through sales and marketing activities, while collecting revenue over the lifetime of the customer. We therefore knew we wanted to take some debt capital markets to complement our equity capital as it is a good fit with the financial profile of the business, and could allow us to continue growing while reducing our dilution. As a startup with a short operating history, it is almost impossible to get normal bank loans, which is where venture debt nicely fills in the gap as venture debt providers know how to underwrite startups much better than banks”. 

Read More : Venture Debt for tech-backed companies during Covid-19

Kevin goes on to share how he eventually decided to go with Genesis. He said that “because we were not just looking for capital – we were looking for partners who could add substantial value to our business. Genesis sets themselves apart from the other venture debt providers in the region on this front, whether it is in terms of helping us with business development to introduce potential partners and customers, advising us on strategy and fundraising, and even government relations. We are very happy that we chose to work with Genesis and look forward to building the company together with them over the long term”.

A venture lender wants to be aligned with the best interest of the founder, the company and the venture investors. Conversely, look for a venture lender who is committed and understands the business needs. The outcome will be a win-win situation for everyone.

In a recent article, Private Debt Investor reported that “venture debt is blossoming” and suggested that “venture debt will surf” in Covid-19’s wake. US venture debt companies are reporting an uptick in dealflow from both existing and new clients notwithstanding “startup layoffs and drying up deal opportunities”.

This might sound counter-intuitive; why would companies leverage up during these difficult times? 

Understanding the principles around venture debt might provide an insight into this emerging trend and help leadership teams assess the suitability of venture debt as a financing option.  

Venture debt today. 

According to Kruze Consulting, US$10bn of venture debt was raised by venture-backed companies in 2019 in the United States alone. Venture debt raised by companies in Southeast Asia is at a fraction today. However, venture debt financing is growing strongly in the region partly given the massive inflows of equity funding (which is a forerunner of venture debt), the maturing ecosystem generally and maturing companies that benefit from alternative forms of funding, including less-dilutive funding, as these companies grow. 

Cash is king. 

Raising venture debt to extend the runway in order to allow the company to gain additional value by the next round of financing has been a key attraction to raising venture debt. Given today’s environment especially, where most companies will be confronted with revenue and growth pressure over the next 6 to 12 months, adding cash to shore up the balance sheet in order to extend the runway is probably a good idea for most leadership teams (and their investors). This is especially so in the case where VCs slow-down funding in the immediate quarters to come. 

Read More : Repost: Venture Debt Market Reaches All-Time High According to Largest Study Ever

Flight to quality. 

Investors are more and more pivoting towards profitability over growth. WeWork’s troubles, coupled with the woes of SoftBank Vision Fund, probably accelerated this view in the last months of 2019. This is now further exacerbated by the new realities of Covid-19. Companies that prioritise profitability (or cashflows) over growth form the staple of venture debt lending. At Genesis, for example, a key part of our investment approach is to seek out solid equity-sponsored companies with strong positive unit economics and without heavy leakage into buying growth. Your company should consider venture debt funding if this sounds like you. 

Less-Dilution. 

Strong companies will continue to successfully fundraise during Covid-19. Historically there have been many opportunities for companies, founders and investors alike in downturns, and hopefully Covid-19 will be no different. However, a common feature during downturns, even for companies that are successfully fundraising, are valuations that are lower (even significantly lower) than previous rounds. And here’s a situation where venture debt can step in to help the company and its founders raise part of this cash without the sting of that additional dilution. 

Also, if a leadership team is raising funds to shore up its working capital needs during this difficult time, raising equity to do so can be a pretty expensive exercise for shareholders (especially with the above in mind). Understanding your working capital needs, and balancing unnecessary equity dilution versus the cost of debt capital, will perhaps push leadership teams to view debt financing more favourably in such circumstances. 

Read More : The Venture Debt Investors Journey in Southeast Asia

Stable VC Presence & Funding in SEA. 

The Southeast Asia tech ecosystem will benefit from recently raised VC capital pre-Covid-19. In addition to the US$20 billion deployed across Southeast Asia tech companies in 2018 & 2019, an estimated additional US$4 billion of capital will be made available by funds for deployment in the region. Armed with this liquidity, VCs will deploy into companies with strong fundamentals and/or companies that can capture the value of markets in a post-Covid world. Together with VC funding, venture debt will be a valuable complement for companies looking to build-up their balance sheets during this time. 

If you’d like to explore raising venture debt as part of your overall capital needs, drop us a note and we’ll work with you to understand your needs.