Venture Debt and Its Importance in Growing SEA Markets

By Iris Capital Partners,

Progressively turbulent times in global markets have caused more startups and SMEs to turn to venture debt options. With interest rates continuously rising, founders are exploring venture debt options that not only allow for reduced shareholding dilution, but also enhanced financial liquidity.

But what exactly is venture debt and how can young companies benefit from it?

Venture debt is an alternative financing method for early-stage startups with validated business models and clear market growth opportunities. It’s a type of loan offered by banks and non-bank lenders designed specifically for high-growth companies who already have existent venture capital backing – and the vast majority of venture-backed companies eventually opt for venture debt financing at some point in the company’s growth.

While venture debt has been present for some time, we’ve seen a huge spike in demand for this option in recent years, partly due to the uncertainty that enshrouded the market during the Covid-19 pandemic and partly due to rising interest rates. To break it down in layman terms, here are a few reasons why companies are looking more and more to venture debt financing:

  1. Reduced equity stake. Venture debt essentially functions as a loan where equity is used as collateral until the full sum of the debt plus interest is repaid, unlike venture capital where equity is sold off to allow for a return on investment. This ensures that founders are allowed to maintain a higher level of control of their company and not dilute their shares.
  2. Predetermined interest rates. Unlike venture capital which sees equity fluctuate (quite drastically on occasion), venture debt is provided based on an agreed upon interest rate which usually is set anywhere between 7-12%. This enables companies to come up with a more structured repayment plan that can span over 5-7 years.
  3. Company valuation. In venture debt financing, a thorough company valuation is not required as opposed to when applying for venture capital.

A question that may come to mind is: How can venture debt actually benefit the Malaysian market, and by extension, the Southeast Asian economy?

A mecca for tech, fashion, and wellness-inspired fast moving consumer goods (FMCG) startups, Malaysia has seen a high influx of new businesses that – thanks to the country’s dense population and proximity to digital havens like Singapore – have been able to scale up in a big way over a short period of time. But oftentimes, these companies hit a glass ceiling, held back primarily by a lack of funds.

In 2021, Iris Capital Partners launched the Iris Fund, Malaysia’s first and only venture debt fund as a way to offer more accessible options to Malaysian SMEs. We saw an opportunity to provide funds directly to founders and businesses that needed capital to either expand its operations or tide over lean times, without raising concerns that equity in the company would be taken.

And it wasn’t just to protect equity stakes. We have also been able to help companies boost their financial standing so the company would be valued at a higher level. This enabled them to raise funds at a higher valuation in their subsequent funding round.

The flexibility surrounding venture debt offers a myriad of opportunities for companies to grow and expand throughout the region in a way that causes relatively low risk to the stakeholders and board of directors alike. And while venture debt typically does not offer nearly as much financing as venture capital, it enables young, high-potential companies  to develop their ideas and share them with the world with relatively low risk.

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