Despite PSL for new economy cos, venture debt still the best bet for early stage startups

The Reserve Bank of India’s move to extend Priority Sector Lending (PSL) to startups is expected to open up institutional lending to the new economy. However, questions about eligibility criteria for these companies remain. 

The announcement also challenges the status quo of venture debt funds that serve the working capital needs for startups in India. 

In 2019, venture debt funds pumped in $171.74 million across 45 deals in the Indian startup ecosystem, according to data sourced from VCCEdge.  In 2020 alone, VCCEdge recorded $62.95 million in venture debt investments across 22 deals in the January to June period. 

PSL requires banks to allocate 40% of their adjusted net bank credit to sectors such as agriculture, education loans, housing loan for the poor, renewable energy, micro, small and medium enterprises (MSMEs) among others. 

Both the startup and the equity investor community in India have welcomed the expansion of PSL’s ambit. 

However, PSL is unlikely to do away with the need for venture debt, according to industry experts. 

“Though venture debt has a higher interest as compared to bank lending, it serves for working capital needs for startups within an average time of two to four weeks. As startups are neither EBITDA (earnings before interest, taxes, depreciation, and amortization) positive and need faster credit, bank loans might not be the right fit,” Shivani Poddar, co-founder at High Street Essentials which runs the brand, FabAlley.

FabAlley raised $1.1 million in a debt round from Trifecta Capital earlier this year. 

While the extension of PSL to startups opens up an opportunity, banks might be required to bring in experts who can under-write the risk for new age companies which are asset-light, according to industry experts.

“Introduction of startups into PSL is a good step to try and solve the working capital need for low risk and mature startups. However it does little for startups which would fall outside of the eligibility criteria,” Vinod Murali, managing partner at Alteria Capital told TechCircle. Alteria raised Rs 960 crore for its maiden fund in 2019. 

He added that as public institutions, banks had a greater responsibility to ensure that the principal amount was secure, thus reducing the risk appetite required to lend to startups.

Nikhil Sikri, CEO of Nexus Venture Partners backed co-living company Zolo Stays said that uptake of bank loans by startups will depend on the eligibility criteria set by them, especially if it takes into consideration profitability.

 “Startups by design are meant to be asset light models and the need for collateral, securitisation and assets for bank under-writing may prove to be a challenge,” Sikri told TechCircle.

The company had raised $7 million in a venture debt round from Trifecta Capital in December 2019 to meet long term investment requirements at lesser dilution, Sikri said.

In order to include startups in a meaningful way into priority-sector lending, it would be necessary that they work with experts who understand how to under-write the risks associated with startups. 

“There are two categories of startups -- those that have raised equity capital from institutional investors and another set which are typically self or promoter financed, which may or may not end up raising venture capital. For the former, specialists like Trifecta Capital become a great partnering opportunity for banks,” Rahul Khanna, managing partner of Trifecta Capital said. The company has backed startups such as  online grocery company BigBasket, wellness and lifestyle app Cure.fit, among others. 

“For the companies which are not venture backed, banks will have to rope in different specialists, who allow them to tap into a long tail of companies whom they typically don’t focus on, much like how they partnered with specialised NBFCs to access certain priority sector segments,” he added.