How Diversified Funding Readies India’s Startups For The Future

India’s technology startup community is enjoying its moment in venture capitalists’ spotlight.

Analysts at Tracxn recently calculated that tech startups in the country raised a combined $14.5 billion last year, a tenfold increase from the $550 million raised at the beginning of the decade.

With India’s tech startup community already off to a promising 2020, investors appear eager to build upon a new track record of high-value, high-volume funding. While that’s good news, the surge in venture capital (VC) funding cannot entirely dismiss the widespread challenges that new businesses face when seeking financing — and according to Avishek Gupta, head of India-based debt and equity investor Caspian Debt, the current demand for startup funding exceeds availability.

The volume of funding available is not balanced with the number of startups seeking funding in India today, he recently told PYMNTS, adding that the current funding climate sees large funding rounds for a few firms, leaving little left for the rest.

“The funding ecosystem in several sectors is still not mature,” he said. “The availability of funds at different stages of the startup lifecycle is not optimum. Some sectors have lots of seed investors, but not for series A or series B stage. Some sectors only have investors for mature startups, but not enough for an early-stage.”

Funding Dead-Ends

This imbalance in the VC arena isn’t the only roadblock that startups in India face today.

According to Gupta, while there is a diverse array of financing products on the market, young companies can often be turned away, and for those that aren’t, certain funding types can lead to financial challenges later on.

Traditional bank loans, for instance, require mortgage collaterals, which startups often lack. There is an initiative underway in India to shift banks’ business lending strategies from one based on net current assets to one based on cash flow, although it’s unclear how this change might expand or restrict access to traditional bank loans for startups.

Digital small business loan marketplaces can be high-risk, he noted, and are best suited for “dealing with small bumps in cash flow in the short-run,” but often will not address the financing need for startups that are more focused on growth than they are on profitability.

Similarly, small business credit cards can offer convenient access to capital but often at a high price, said Gupta. Poor performance in banks’ portfolios has also led to restricted availability of this kind of credit in India, he noted.

Mixing the Right Funding Combination

Each financing product has its advantages and drawbacks, and no single solution will be a perfect fit for a startup. As such, Gupta emphasized the importance of combining an array of financing tools, which can enable businesses to ensure that the financing they access will be most appropriate for its purpose.

“Diversifying funding sources allows startups to match the nature of funds and the uses of funds,” he said. “Equity is long-term and patient capital, and hence should be used for long-term investments where the timing of cash flows is not certain, like in new product development and filing patents.”

Debt, meanwhile, should be used in cases where cash flow is more predictable, for instance when a startup purchases assets resulting in an immediate cash flow jump — a strategy important to preserving equity, Gupta said.

Often, a startup’s strategic use of a combination of debt can be key to supporting their VC ambitions.

“As per our experience, companies that have raised debt from more than one source are more likely to raise another round of equity,” he added.

That strategy of mixing multiple funding sources is what led Caspian Debt to recently announce a partnership with the Indian Angel Network (IAN). The companies signed an agreement to promote diversified funding for startups and small businesses by combining Caspian’s debt and equity capital offering with IAN’s angel funding.

Finding Investors’ Right Fit

While India’s VC ecosystem is robust, VC investors around the world are not immune to risks.

The recent failed IPO of WeWork placed SoftBank’s Vision Fund on the defensive and generated a broader conversation about later-stage funding’s drawbacks. In India specifically, despite a record VC year, analysts are warning that investors’ excitement in the India tech market may lead to a cool-down.

“The fundraising environment has totally changed,” Deepak Shahdadpuri, founder of VC group DSG Consumer Partners, told the Financial Times earlier this month. “There are companies that were chased and sought after, and now it’s getting hard.”

The Indian Private Equity and Venture Capital Association recently issued a warning that tax administration uncertainty is a major threat to India’s private investment industry, while other analysts predicted a VC slowdown.

According to Gupta, investors must be diligent about their funding targets, with startups’ financing strategies an important piece of that puzzle.

“When a company is growing fast, generating healthy cash flows and has a controlled burn rate, debt can be a cheaper form of financing that can save the promoter and early investors from further dilution at unfavorable terms,” he explained. “In fact, this improves returns for the equity investors and is hence seen positively by future equity investors.”

By mixing funding sources like debt and angel funding, startups aren’t just reinforcing their own finances — they can also support investors’ financials, too.

“This mix of angel investment and debt can work towards a mutual benefit for some companies that have revenue traction and a clear profitability,” Gupta said.