If Singaporeans were asked to name a successful startup company in 2010, chances are they may not even be able to name one startup. Fast-forward to 2015, there were dozens, if not hundreds, of successful startups based in Singapore. Now in 2022, it seems as though a new startup is raising capital almost every day.
Traditionally, most of these companies raise equity as their sole source of capital. However, venture debt is quickly emerging to be an alternative and complementary source of financing for high-growth startups. To date, roughly 80-100 Southeast Asian companies have benefited from venture debt and qualified deal flow has increased by 31% quarter-on-quarter between January 2020 and March 2021..
Last month, Helicap had the opportunity to be featured alongside Genesis Alternative Ventures on The Expert Series hosted by SEA Founders to discuss the features and benefits of venture debt.
In this issue of the Helipad, we focus on the rise of venture debt financing in Southeast Asia and how it has established its critical role in boosting the local startup ecosystem.
What is Venture Debt?
When startup founders look to raise capital, they look to debt financing because it does not dilute shareholders’ equity. Yet, as banks are wary of the risks associated with financing startups, they are usually unable to approve loans or do not provide favourable loan terms. Hence, startups turn to venture debt financing.
Venture debt is a form of debt financing, obtained by startups or venture-backed companies. Startups look to venture debt as an alternative source of capital because it attracts higher valuations and grows businesses without additional equity capital and dilution. Although these companies typically do not have positive cashflow, they are able to obtain the loan based on their growth potential, funding from venture capital firms, and cash runway.
So, then what do venture debt investors get in return?
Venture debt providers usually issue loans in exchange for stock warrants, which typically represent 15-20% of the loan principal amount. Subsequently, these stock warrants can be exchanged for common or preferred stocks with potential equity upside, allowing venture debt providers to charge the startup lower interest rates. Should the startup’s valuation increase at a subsequent funding round, venture debt providers will be able to exit their equity position with a potentially large upside.
When used appropriately, venture debt financing can help to extend the company’s cash runway and allow the company to hit their performance indicators set by equity investors between fundraising rounds. One other benefit is that venture debt financing boosts cash reserves, allowing the company to meet any short-term cashflow issues. As venture debt is ultimately a loan instrument, taking on this form of financing helps to avoid an over-dilution of shareholders’ equity in the early stages of the company’s growth.
Figure 1: Benefits of Venture Debt
Key Pillars of a Venture Debt Loan
Before looking for a venture debt lender, there are several basic terminologies that startup companies would need to understand. Each venture debt loan agreement includes contractual obligations on both the borrowing and lending parties as lenders rely on these terms to protect their investments. These contractual obligations are stated in the term sheet and can be negotiated with the lender, usually alongside their respective legal parties, to ensure the protection of both their interests. At this juncture, companies will need to assess the significance and the risks associated with these obligations. These obligations are outlined in the graphics below:
Figure 2: Key Pillars of Venture Loan Term Sheet
While venture debt may seem like an effective source of funding, it is important for companies to fully understand their loan terms in order to maximize the benefits and minimise the risks of taking on venture debt.
The most important risk to take note of is that venture debt is still ultimately a loan, requiring the principal to be repaid in full regardless of the company’s performance. Lenders would therefore be more inclined to propose stricter terms to ensure the repayment of loans. This can include taking a lien against the assets of the company, which may include intellectual property.
When companies take on a loan from venture debt lenders, they are also bound by the covenants stated in the term sheet. These covenants are metrics set out by the lender to ensure that their investments are protected. Some examples of these metrics include liquidity ratio, current or quick ratios and capital adequacy ratio. The problem is that these metrics may not be an indicator of profitability. Some venture debt lenders view these metrics as an indicator of success to their investments, but ultimately, it may not necessarily indicate that the business is growing. Companies would need to be clear on the consequences of achieving and maintaining these metrics before taking on a loan, as it may pose restrictions that hinder their business growth.
Understanding the term sheet of a loan agreement requires extensive knowledge of the terminologies and the implications of the venture debt offering. It is beneficial to consult a lawyer to understand the terms and conditions before negotiating for more favourable terms. Hiring a legal party may incur a large amount of fees and companies would need to be able to bear such costs when taking on a loan to finance the growth of their company.
The Venture Debt Landscape in Singapore
Despite being an established form of financing in other parts of the world, venture debt financing has only gained popularity in Southeast Asia over the recent years. Since 2015, the market has seen an increased demand for venture debt as a source of financing. As part of its effort to build the venture debt landscape in Singapore, the Singapore government introduced a S$500 million Venture Debt Programme (VDP) in 2016 to provide funding to local early-stage and high-growth small- and medium-sized enterprises for business growth and development. This ultimately encouraged local banks such as DBS to move towards providing venture debt as a funding option for startups.
Amidst COVID-19, Venture Debt Continues to Strive
“Venture debt in Southeast Asia has been thrust into the limelight during the Covid period with entrepreneurs seeking more efficient capital and putting in place additional capital buffers.” 
Dr. Jeremy Loh
Co-Founder & Managing Partner, Genesis Alternative Ventures
During the COVID-19 pandemic, venture capital firms became more demanding of startups when it comes to proof of concept and suitable product fit. This led many startups to consider venture debt as a source of funding, resulting in a sustained increase in demand for venture debt despite the pandemic. Consequently, venture debt emerged as a crucial source of funding for boosting the startup ecosystem in Singapore and Southeast Asia, with many companies utilising venture debt to cope with challenging market conditions.
As a result, the Singapore Government also enhanced the VDP during the pandemic, increasing the maximum loan quantum from S$5 million to S$8 million, and agreed to bear up to 70% of the risk on eligible loans with participating financial institutions.
Venture Debt VS Convertible Debt
Like venture debt, convertible debt is also a form of debt financing. The key difference is that instead of repaying the full amount, startups agree to convert the loan amount to equity at a specified date, which typically occurs during the next round of funding. Hence, convertible debt is more dilutive than venture debt.
Convertible debt notes are generally provided by investors who already hold shares in the company or by investors who are typically coming in at an early stage of the company’s growth. Between funding rounds, shareholders may also provide convertible notes to boost the company’s cash reserve during a cashflow crunch. Interest rates are far lower than venture debt, as the return of investment for convertible debt lenders would come from the flexibility of being able to convert the debt note into equity.
Figure 3: Equity vs. Debt vs. Convertible Debt
Source: Flow Capital
The Road Ahead for Venture Debt
The future for venture debt is one to be optimistic about. Fuelled by increasing demand and easing Covid-19 restrictions, more startups will turn their attention to venture debt providers when sourcing for alternative funding to accelerate the growth of their business. Venture debt has become a significant contributing factor towards the booming startup landscape in Singapore, and is poised to retain its key role in the years ahead.
The Value of Venture Debt to Startups (Ventures, Genesis Ventures, 2021)
Genesis Alternative Ventures Closes Southeast Asia’s first venture debt fund at US$80 million (Ventures, Genesis Ventures, 2021)
Genesis Alternative Ventures closes $80m for first SEA venture debt fund (Cordon, Tech In Asia, 2021)
A Changed word: the New horizon for start-ups in Southeast Asia (Two Birds, 2020)
Budget 2021: Venture Debt programme for high-growth enterprises to be extended and enhanced (Ramchandi, Budget 2021: Venture Debt programme for high-growth enterprises to be extended and enhanced, 2021)