By Karun Arya
Backed by an ever-increasing battalion of new ventures, including unicorns and soonicorns — India’s startup landscape has witnessed unprecedented growth over the last few years.
With over a dozen businesses set up to join the Unicorn Club in 2024, the startup ecosystem in India is positioned to grow in scale and importance in the broader global context.
While the macro environment has changed massively in the last few years and factors like global inflation and valuation complexities have led to a recent funding dip — India’s startup appeal remains strong.
The good news is that as per industry estimates, more than $20 billion for significant dry powder is held by India-focused funds, eagerly awaiting opportunities for deployment.
With businesses having a plethora of lending options — they may go for traditional avenues of raising funds such as bank loans or equity financing, or explore Alternative Financing (Alt-Fi) options like revenue-based financing, cash flow lending, and more. The choice often depends on factors such as the business model, funding stage, revenue generation cycle, and areas where the capital is proposed to be deployed.
Growing preference for non-dilutive financing
As the landscape of the startup ecosystem in the country changes rapidly with a significant transformation in the global market dynamics, it becomes crucial for businesses to stay relevant and have a consistent inflow of capital.
The funding winter or current slump, as most industry analysts call it is “a natural part of a capitalistic fluctuating cycle”. Startups with innovative ideas and strong fundamentals are well-positioned to get funded.
Previously, most entrepreneurs seeking capital in the early stages turned to equity financing either through angel investors or venture capital. However, equity financing comes with its own set of pros and cons — something every entrepreneur should be acutely aware of. As new shares are issued to investors, existing shareholders’ ownership stake decreases. This means founders and early investors may lose control over decision-making processes, and may receive a smaller share of future profits or potential exit proceeds. Then there is also the added pressure from investors to grow at speed, sometimes at the cost of corporate governance.
Moreover, if new shares are issued at a lower valuation than previous funding rounds, it can indicate a decline in the perceived value of the company, which may impact investor confidence and future fundraising efforts.
If all this means putting off your next equity financing round, then it’s worth considering. When faced with operational or working capital requirements such as boosting your performance marketing budget or venturing into new markets — consider embracing non-dilutive financing solutions like quasi-equity financing tailored to your specific risk-return profile.
Unlike equity financing, non-dilutive options allow businesses to secure funding without sacrificing ownership stakes or diluting existing shareholders’ interests. This approach can mitigate the pressure associated with traditional equity financing while providing the capital needed to fuel growth initiatives.
Over the past two years, the trend towards non-dilutive financing has gained momentum in India. According to Redseer’s ‘India Digital SME Credit Report’, with over $100-200 million deployed in revenue-based financing in the last two years, new-age businesses in the country have tapped into this innovative funding model to support their expansion plans and operational needs.
Startups are poised for quasi-equity financing in 2024
Founders with recurring-revenue businesses increasingly turn to Alt-Fi platforms to fulfil their working capital needs, particularly in sectors like supply chain, D2C, Climate Tech, and B2B SaaS.
Over 80% of founders advocate leveraging debt financing between funding rounds. This significance is particularly emphasised in the current funding climate where equity investments are declining.
In recent times, quasi-equity has also come to the forefront as the preferred source of financing for startups, especially when share capital and debt financing may not be ideal primarily owing to dilution of ownership and in most cases, limited credit history or collateral.
Quasi-equity combines features of both debt and equity instruments but typically involves less dilution of ownership compared to equity financing and flexible repayment terms in contrast with traditional debt financing.
In the process of raising capital for a business, the key is to understand the difference between chasing valuation and value creation. As much as founders would love to value their businesses highly, it’s rather more important to have a sustainable and scalable business that runs smoothly even during times of crisis. With quick growth aspirations straining startup finances, quasi-equity financing is the ideal option. This type of financing allows founders to access working capital for growth while minimising dilution of ownership and maintaining flexibility in repayments.
The way forward for startups in India
As a founder, it’s imperative to carefully assess your capital stack and devise a strategy that aligns best with your business objectives, helping you with a runway for the next 12-18 months. A blend of equity and quasi-equity financing often proves to be the most effective approach for many businesses. To break it up — startups can secure equity financing for long-term innovation and the latter for short and mid-term growth goals and working capital needs.
In 2016, Prime Minister Modi launched the Startup India Action Plan in an effort to lay the foundation of Government support, schemes, and incentives designed to create a thriving startup ecosystem in the country. The Credit Guarantee Scheme for Startups (CGSS) was established by the Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry to support entrepreneurship through credit to innovators and encourage banks and other member institutions in the ecosystem for providing debt to emerging businesses and startups.
Of India’s 64 million MSME base, the growing number of young SMEs and startups estimated to be in the 7-10 million with some digital revenue streams have a growing credit requirement that is projected to exceed $570 billion by 2026. This presents a significant avenue for our economy to thrive.
The opportunity for stronger and more embedded public-private partnerships driven by strategic initiatives like OCEN (Open Credit Enablement Network) and greater collaborations among key ecosystem stakeholders will be crucial. For startups looking to scale in India and overseas from India, the way forward will be supercharged by better access to all forms of capital including debt and equity, and other financial products and services that are founded on the India stack and delivered using technology.
Karun Arya is the Chief Growth Officer at GetVantage. Views expressed are personal.
