Sustainability and Growth lie in Capital Diversity

With equity investors tightening their purses, start-ups looking for growth capital should explore a diversified pool of resources consisting of an optimal mix of investments from venture debt companies, family offices, HNIs, and revenue-based financing companies. The best part of such a broad-based approach can help founders raise funds that complement their business model as well as avoids any excess equity dilution.

Nowadays, a lot has already been written about the so-called `long winter of funding’ that has been casting its shadow on the start-up ecosystem. The big-time backers of the new-age technology companies – from SoftBank Vision Fund to Silicon Valley venture capital giant Sequoia Capital in different missives have warned the founders of a dry spell.

The message: do not expect us to cut the next cheque any time soon and they (investors) will think about fresh funding after portfolio companies start showing profits. The investors may not be ready to shell out more equity for less money as valuations have plummeted. As a result, there has been an erosion of equity capital flow into the startup eco-system due to central banks’ policy tightening measures across the globe accompanied by rate hike to address the inflationary impact.

Headline numbers on private investment in the start-up space support this theory. According to a recent report, VC/start-up investments in April 2022 declined by 50% y-o-y to $1.6 billion across 82 deals. The decrease is mainly attributed to the absence of any large deal or new unicorn. These numbers, however, tell only a part of the story.

Lean start-ups who deploy their capital prudently as well as preserve it, growing at a faster clip, thus adding value to investors have no need to worry about raising fresh capital. Instead of the conventional equity route, they should look at a diversified pool of capital such as venture debt, investments from family offices and HNIs, and revenue-based financing to meet their funding needs. This diverse outlook can help founders raise funds without diluting any further equity.

There is already a list of start-ups that have managed to sustain their growth by adopting this strategy. For instance, the cap table of cloud kitchens and online-only restaurants CureFoods Pvt Ltd shows that the company has landed funds from a pool of sources. Its capital providers include Chiratae Ventures and Accel Partners for equity, Alteria Capital, Blacksoil capital and Trifecta Capital for venture debt and HNIs such as Flipkart cofounder Binny Bansal, actor Varun Dhawan etc. as individual long-term investors.

Another such example is direct-to-consumer (D2C) and home care products startup Clensta International Pvt. Ltd. which too has sourced funds from a diversified pool of investors which includes revenue-based debt fund N+1 capital.

A closer look at the capital sources of a number of start-ups also reveals that the founders have seen the writing on the wall –`the money is no longer free’ – well in advance and retooled their funding strategy accordingly. This is mirrored in the amount of venture debt deployed in the start-up space which has indeed doubled to $538 million in 2021 from $271 million in 2019, according to `India Venture Debt Report 2022’ by Stride Ventures’.

Similarly, there are a host of investors who are offering revenue-based financing which goes a long way for the start-up to live within their means. Finance providers such as N+1 Capital offer both venture debt and revenue-based financial solutions. Also, over the years, family offices and HNIs as individual investors are doubling down on technology companies with high profit visibility with their private money.

However, the core issue to be reckoned with is the fact that a one-size-fits-all approach may not work in a fast-changing financial scenario. Each start-up has its own funding needs and should look for a source of capital that provides optimum value. Therefore, it is only prudent for them to collaborate with experts who can navigate them through their funding round efficiently.