#Asia Emergence of venture debt in Southeast Asia

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Is venture debt an alternative source of capital to push the equity model aside, or just a useful form of complimentary financing?

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What is venture debt?

It’s certainly not new. Venture financing has helped support startups for decades particularly in Silicon Valley. However, this form of financing is becoming popular in Southeast Asia as financial institutions try to engage with emerging companies.

Venture debt often supplements an equity round by providing additional capital — but with the upside of limited further dilution. It is senior debt that typically includes the issue of warrants (a right to subscribe for shares in the future at a fixed price). Venture debt should be distinguished from convertible instruments, i.e. unsecured debt which converts into equity on the next financing round. Venture debt, on the other hand, is not convertible but will be secured against the assets of the company.

Some advantages/disadvantages vs. equity financing

Advantages Disadvantages

 

Can be used to supplement an equity round by providing additional capital

 

It is debt, so the company will need a clear strategy to repay the loan.

 

The debt component is non-dilutive (though exercise of the warrants will eventually result in some dilution)

 

The loan is a liability which must be repaid, plus will be a regular cash expense for the business as interest accrues
Simpler documentation and quicker to execute

 

Debt terms typically harder to negotiate

 

Venture lenders rarely take board seats Interest is payable immediately following draw down

 

Less governance requirements

 

The lender can potentially force a liquidation of the company on default

 

What issues should founders look out for?

Aside from considering the commercial issues, including the amount, term and interest, companies will likely be presented with a loan agreement, debenture and warrant instrument. The first two of these documents need the most attention.

Loan Agreement:

  • Try and delay the draw down date to reduce the cost of the debt and extend the runway
  • Potentially seek a liability cap and/or exclude all indirect and consequential loss
  • Note that negative undertakings in favour of the lender can be restrictive on the operation of the company
  • Narrow down, or qualify by materiality, “events of default” which may allow the lender to immediately call on the outstanding balance of the loan
  • Note any “cross default” provisions, i.e. that categorise a default by a subsidiary of the group as an event of default of the borrower

Debenture

  • Avoid formally assigning the assets of the company to the lender which is difficult to manage
  • Check that restrictions on how the borrower can deal with charged assets are workable
  • Carefully review exclusions of liability in favour of the lender
  • Check the lender’s assignment rights and whether the company’s consent is required

Round-up

Whilst it is called venture debt, the commercial terms presented are not necessarily startup friendly. You can expect fully secured loan documentation with terms and covenants similar to that issued by traditional debt providers.

If you do raise venture debt, don’t hand over control of all key decision-making to the lender. The same of course applies to your equity investors. Remember that taking any debt will likely require the approval of existing shareholders. Future investors will also want to review the terms carefully in their due diligence as outstanding debt in a business impacts on both the future cash coming in, and treatment of investors on liquidation.

There’s no doubt that venture financing can be a helpful tool for startups and growth companies to help extend runway, or to avoid a bridge round which can be dilutive. But if the company cannot repay the loan when the time comes, it is at risk of default unless it can refinance. So if your company is not performing, or unlikely to raise future equity, avoid venture debt. 

Lee Bagshaw co-authored this article with Chris Wilson. Both are corporate lawyers at technology law firm Simmonds Stewart. They advise investors and startup companies on venture capital and tech M&A transactions across Asia Pacific.

The views expressed here are of the author’s, and e27 may not necessarily subscribe to them. e27 invites members from Asia’s tech industry and startup community to share their honest opinions and expert knowledge with our readers. If you are interested in sharing your point of view, submit your post here .

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