The Future of Debt Funding: Trends and Innovations in Startup Investment 2024

The future of debt funding is evolving rapidly, with new trends and innovations reshaping the landscape of startup investment. Take a closer look at the rise of debt funding for startups and MSMEs, and explore the funding tools and strategies emerging in the market.

India has come a long way from being apprehensive about startups to now having a thriving ecosystem with many structured ways of raising capital to run and scale effectively. In fact, as the ecosystem matured through various cycles, it is interesting to note that debt has emerged as a popular funding option for many businesses.

Debt funding refers to borrowing money from lenders with the promise of repaying them with interest, within a specified time. Unlike equity, debt helps protect shareholding and ownership of the business while being empowered with the capital to unlock growth.

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The Rise of Debt Funding in Startup Investment

Notably, alternative forms of funding, especially debt for startups, have seen a dramatic rise in the last couple of years. As the funding winter significantly drained capital infusion in startups, founders saw debt as a reliable source of capital to continue building and sustaining business growth.

“Debt financing is a faster and more reliable source of funding for businesses, which can help them grow their businesses without losing ownership of the business. It helps companies to leverage a small amount of money into a much larger sum, enabling more growth, which may otherwise be difficult,” Gagan Aggarwal, CFO of Clix Capital, told Mint.

In 2023, venture debt funds hit the $1B milestone in investing, which is an increase of 50 percent from the previous year while equity fundraising declined by about 35 percent to $39 B, according to several industry reports.

As we look towards investment trends 2024, debt funding is expected to play an increasingly significant role in startup financing. This shift reflects a growing maturity in the startup ecosystem and a desire for more flexible funding options.

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Innovative Debt Funding Tools for Startups

Innovation in funding and financing solutions for startups, MSMEs, and other emerging businesses are also on the rise. Within debt, one can opt for different kinds of instruments including bank loans, term loans, working capital loans, loans against collateral from NBFCs, vendor financing or invoice financing, corporate bonds, debentures, and trade credits.

1. Traditional Term loans: Traditional bank loans and term loans remain foundational for many businesses. They provide structured capital with fixed repayment schedules, typically suited for long-term investments in assets or expansions.
2. Working capital loans: Crucial for day-to-day operations, working capital loans ensure liquidity for inventory purchases, payroll, and other immediate expenses. They are often short-term and can be secured or unsecured, depending on the lender's risk assessment.
3. Loans against collateral from NBFCs: Non-Banking Financial Companies (NBFCs) offer loans against collateral such as property, machinery, or even financial assets like stocks or mutual funds. These loans provide higher flexibility in terms of collateral types and can be quicker to process compared to traditional bank loans.
4. Vendor financing or invoice financing: This can be particularly beneficial for capital-intensive businesses with large orders or delayed payments. Vendor financing and invoice financing allow companies to leverage their accounts receivable as collateral to secure immediate working capital. This helps maintain cash flow and operational continuity without waiting for payment cycles.
5. Corporate bonds and debentures: For businesses seeking long-term debt capital, corporate bonds and debentures offer an avenue to raise funds from investors in exchange for periodic interest payments and eventual repayment of principal. These instruments can diversify funding sources beyond traditional loans.
6. Trade credits: Trade credits involve suppliers extending credit terms to buyers, allowing businesses to defer payment for goods and services received. This arrangement supports cash flow management and operational flexibility, crucial for managing growth phases.

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As startup investment evolves, these debt funding tools are being tailored to meet the unique needs of high-growth companies. In 2024, we expect to see further innovations in these instruments, particularly in areas like revenue-based financing and AI-driven credit assessment.

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Emerging Trends in Debt Funding for Startups

• The Rise of 'Equidebt' Funding: An interesting strategy that LetsVenture has spotted in the last couple of years is topping up an equity round with debt or combining the two in what we have termed as an 'Equidebt' funding. In such a round, businesses safeguard their equity stakes to a certain extent while not taking the big risk that comes with debt funding at once.
• Addressing the MSME Credit Gap: In keeping with the demand for debt, there is no lack of lender or financing solution in the market today. Many are riding on the $530B credit gap opportunity to serve 64 million MSMEs in the country today as well as fill in the funding needs of new age tech startups.
• Specialized Debt Financing Solutions: With a deep understanding of how startups and lean businesses function over the last decade of working on funding startups, LetsVenture also offers comprehensive debt financing solutions through LV Debt.

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Conclusion

As the startup ecosystem continues to evolve, debt funding is poised to play an increasingly vital role in supporting business growth. The investment trends 2024 suggest a more nuanced approach to startup financing, with debt instruments offering a balance between growth capital and founder control. However, as with any financial decision, founders must carefully evaluate their options and choose funding partners who understand the dynamic nature of startups and emerging businesses.

As a founder, one must make sure lenders understand the dynamic needs of an MSME, startups, or an agile business. It is important that founders exercise careful evaluation before committing to debt agreements as it will be a lasting relationship till the repayment is complete.