 "Rahul Khanna & Nilesh Kothari")
Rahul Khanna, till recently managing director of venture capital firm Canaan Partners, and Nilesh Kothari, former M&A head of Accenture India, have joined hands to set up a Rs 300-crore venture debt fund targeting high-growth start-up companies. Khanna and Kothari tell Sudipto Dey why venture debt funding is set to grow three-fold in India over the next three years. Edited excerpts:
Canaan Partners has invested $120-150 million in India since 2006. With the two founding partners - Alok Mittal and you - getting back to entrepreneurship, what happens to the investment portfolio?
Rahul: We will continue to support our existing portfolio. As an organisation, Canaan Partners is around 30 years old and has tremendous experience in managing portfolio. We will continue to find a way to support these companies through incremental capital and guidance. Both Alok and I continue to support the Board seats that we are involved with. Right now, we have 10 portfolio companies in India, and we have provided the CEOs and the founders the comfort that we will continue to support them as they grow. We just will not make any new investments.
There were reports that your portfolio is on the block?
Rahul: I can't comment on that. It is a pretty high-quality portfolio, and we have had some overtures from our existing investors, who have invested in Canaan. Any decision around Canaan India will largely be taken by partners in Canaan United States.
Have the lack of exits through IPOs and low appetite among Indian companies for domestic acquisitions been the biggest challenges in the start-up ecosystem?
Rahul: From a Canaan perspective, we have been more and more focused on the US. But venture firms focused on India have raised dedicated funds for India. Canaan did not follow a dedicated-fund approach. This partly means that every deal that needs to be done has to be looked at globally, and measured against every opportunity in the US. The fact is US has been an attractive market for venture funds, while India has lagged on the exit side.
Is it the right time to launch a new asset class - venture debt?
Rahul: We believe that the venture ecosystem has reached a critical stage. Largely, the people who are here will continue to be here. The next big opportunity for the next 10 years is to create a new asset class that supports the existing venture capital ecosystem. Venture debt is an extension of venture capital ecosystem. As companies raise equity capital, they also have a need for debt. Technology, IP and services companies are typically not serviced by banks. As companies look to open new offices, raise capex spends, look to make deposits, they have to dilute equity to do that. Like in any other business, there is a healthy requirement for debt and equity. Globally, venture debt is around 15 per cent of venture financing asset class. For instance, in the US, which is a $30-billion equity market, the venture debt as an asset class is worth $3-5 billion.
Similarly, in India, we believe there is almost Rs 1,000 crore worth of venture debt to be written every year. There are not many platforms doing justice to this opportunity.
Nilesh: As venture financing grows, so will demand for venture debt in India.
But why would start-ups look for venture debt when so much of equity capital is available in the market?
Nilesh: Venture debt typically follows venture capital. So when venture capital achieves a certain scale, that's when venture debt follows. Silicon Valley Bank's Indian subsidiary (SVB India) has given out around Rs 600 crore in venture debt over the past five years. SIDBI has been doing venture debt, too.
From a promoter perspective, equity is expensive. Generally, a venture capitalist's expectation of return is north of 30 per cent. But by going for venture debt, you are effectively signing up for a short-duration loan - typically for two-to-three years - at an interest rate of 16-18 per cent. By taking a combination of equity and debt, the amount of debt you take is largely non-dilutive, while equity is something you give up for ever.
Given that we are lending to high-growth companies, we take a small portion (around 10 per cent) in warrants in the company. We will exercise that warrant and convert that into equity when the company's valuation goes up.
India is very founder- and promoter-centric, so protecting ownership becomes all the more important. Saving that ownership early on is important as it is needed latter in ESOPs (employee stock ownership plans) to attract more talent. The other reason many promoters go for debt is to get better cash run, achieve more milestones and get better valuation. Many a time, venture debt helps companies extend their life cycle between two rounds of funding.
Any estimate of the venture debt market over the next two-three years?
Rahul: SVB India does Rs 80-100 crore of fresh loans every year. We, too, are targeting Rs 100-120 crore of new loans from our first fund. The venture capital industry is growing at 10-15 per cent a year. Venture capital can be a $1.5-billion industry in the next three years. At that point, venture debt could be three times the size of what it is today - estimated at $250 million.
How will you be different from competition?
Rahul: We will be structured as an Alternative Investment Fund (AIF) Category II. This means, we can raise funds from domestic investors once we get Sebi (Securities and Exchange Board of India) approval, and return those funds fairly easily. We see a lot of opportunities for family offices and family businesses to participate in early-stage companies in e-commerce space, which they might have missed earlier. Also lot of entrepreneurs realise it is not about money - but also the colour of money, the brand, and relationships. We will invest in companies that have raised series A or B round of funding.
