Gone are the days of idolizing businesses run without debt or viewing debt as a burden. Today, financial institutions consider having a credit history of borrowing and repaying a good sign of business engagement.
“In fact, many modern-day entrepreneurs actively seek loans even when they have enough capital just to prepare a case history and solely to establish a track record,” says Shanti Mohan, Founder and CEO, LetsVenture, in conversation with Pramod Lamba, Head of Sales, LV Debt, in an engaging AMA, Funding Fridays, organised recently to answer queries of founders around debt funding.
Here are the top takeaways from the online webinar to educate entrepreneurs about various fundraising tools.
Vintage of the company matters
Lenders care about how long the company has been in business. A newly formed company in the pre-seed stage may find it difficult to secure debt. It is always better to have completed at least one financial cycle so there’s a financial statement to showcase the state of the business.
Most non-banking financial companies (NBFCs) prefer lending to companies that are at least three years old. Albeit limited options, younger companies can still make a case by showcasing business acumen to raise debt in the early stage. However, such options often come at higher rates and less favourable terms when compared with debt options for companies that have more vintage.
Showcase ability and willingness to pay
A business’s ability to pay is just as important as its willingness to pay.
Lenders usually assess the ability to pay through business revenue and consider disbursing a loan of anywhere between 10 to 25 percent of the top line depending on risk appetite. Hence, the greater the revenue, the greater the chance of securing higher debt.
However, the intent or the willingness to pay is also an area of concern for lenders. This can be through records of Days Past Due (DPD), which show punctuality in repayment behaviour.
“I've seen cases where debt funding of Rs 1Cr is rejected because of an outstanding amount of Rs 5000 on credit card. Such slip-ups can be costly,” says Pramod.
Keep the runway in check
The ideal time to start fundraising for debt is when you have a runway of at least five to six months, especially in the startup world where ‘burn’ culture is prevalent. Getting a loan will become increasingly more difficult as the runway tapers down further.
“However, at times, we do special approval on certain cases. For instance, we can give debt if founders have raised one round of equity, are in between two equity rounds, or have shareholders’ agreement (SHA) signed with cash in the bank likely to hit in the next 15 days,” Pramod adds, speaking about LV Debt, a pure-play debt funding solution for startups and emerging businesses.
Do not over-leverage
The ability to get a loan is not a reason to secure as much debt funding as possible. The Reserve Bank of India (RBI) has severely reprimanded unsecured lending because people are taking multiple loans from different vendors. A business that is capable of servicing only Rs 10 should not have Rs 40 in loan repayment in EMI.
In the end, the founder must decide whether the business is equipped to face the challenges of being over-leveraged because ultimately, the business has to start paying the EMIs.
Debt can be risky debt.
While debt can champion business growth when put to strategic use, founders must also be aware of the risks associated with debt because in times of crisis, debt can be very unforgiving.
Businesses must understand the impact and carefully read term sheets and note the assets getting attached in case of failure to repay.
“We’ve seen that happening. A SaaS startup running very well for six years with $10M ARR took debt to scale. But then the pandemic struck, their revenue started dropping, and the debt investor bought out all the IP. The company had to shut down,” Shanti says, emphasizing the worst-case scenario.
At the same time, with the right strategy, debt can set the stage for impressive growth. Highly successful startups in India such as Country Delight, BluSmart, MyGlamm, Homelane, BigBasket, among others, have scaled on the power of debt.
To know more about alternative forms of funding, join our upcoming expert-led AMA.
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