Some 18 out of Silicon Valley's 20 largest unicorns have used venture debt in order to reduce shareholding dilution, extend their runway, and accelerate growth with limited cost to the business. Chin Chao and Paul Ong of regional venture debt leader Innoven Capital offer a primer for Indonesian entrepreneurs on this rapidly growing form of fund-raising. Positioned as a "synergistic partner" to their VC counterparts, Innoven commonly connects portfolio companies into the ecosystems of anchor LPs Temasek and UOB.
Some 18 out of Silicon Valley's 20 largest unicorns have used venture debt in order to reduce shareholding dilution, extend their runway, and accelerate growth with limited cost to the business. Chin Chao and Paul Ong of regional venture debt leader Innoven Capital offer a primer for Indonesian entrepreneurs on this rapidly growing form of fund-raising. Positioned as a "synergistic partner" to their VC counterparts, Innoven commonly connects portfolio companies into the ecosystems of anchor LPs Temasek and UOB.
ALAN 0:12
Welcome to the 28th episode of Season Two of the Indo Tekno podcast. Selamat datang semuanya. I'm Alan Hellawell, founder of tech consultancy Gizmo Advisors and Venture Partner at Alpha JWC Ventures. With today's episode, we profile a fundraising vehicle which I have found that few entrepreneurs are familiar with in this part of the world. Venture debt is a type of debt financing available to early stage companies and startups. This type of debt financing is typically used as a complimentary method to equity venture financing. Innoven Capital is Asia's leading venture debt and lending platform, providing debt capital to some of the region's most promising tech startups. Today, we're very pleased to have Innoven Capital Southeast Asia CEO Chin Chao and his colleague Director Paul Ong join us today to talk about the benefits of venture debt. Gentlemen, thanks so much for joining us today.
CHIN CHAO 1:08
Thanks for having me, Alan.
ALAN 1:10
You're very welcome, Chin.
PAUL ONG 1:11
Thanks for having me on the show. Big fan of your podcast, Alan.
ALAN 1:15
Paul, thanks a bunch. You're very kind. Chin, I'll start off with you. Now I came to know of you as an MD at Venture TDF during your 15-year career investing in the likes of Alibaba, Baidu and others. What led you to shift from straight venture capital investing to venture debt?
CHIN CHAO 1:32
So, interesting story. As part of my career at Venture TDF, we had actually set up what I consider the first venture debt programme in Southeast Asia. We had set something up in 1999-2000. And we worked with a local bank here in Singapore. We worked with the local government in Singapore to set up something very similar to what Silicon Valley Bank was doing at the time. We ran that for a couple years, and the bank decided that it didn't want to continue, and we had to stop. So Innoven was my second bite at the apple to do venture debt in the region. And so when UOB and Temasek reached out and said: "Hey, would you be interested in helping us grow this business?" I said I had unfinished business in this space. So I decided let's try to build up another venture debt outfit the same way I built up what we tried to do back in 1999, and 2000.
ALAN 2:17
So Chin, share with us a little more about Innoven, the history of the firm, if you don't mind.
CHIN CHAO 2:22
Sure. Innoven started off in India around 13 years ago as a subsidiary of Silicon Valley Bank. In early 2015, if I remember correctly, Temasek and UOB acquired the India business from Silicon Valley Bank, and renamed it Innoven. They started the Southeast Asia office later that year in 2015, and then started our China operations in mid-2017. So currently, we have offices in India, China and in Southeast Asia.
ALAN 2:49
Chin, why venture debt?
CHIN CHAO 2:51
The short answer is that venture debt is cheaper than equity, and saves founders and management teams from too much dilution. We've modelled it out internally, and venture debt can be 50 to 100 times cheaper than equity financing. So if you look around the world, all the best and biggest companies have some responsible reliance on debt that they've used to grow their business. But startups and tech companies, they've never been able to obtain financing from traditional banks, just because they have no hard assets and they're burning cash. But with venture debt, they finally have a way to tap into some less expensive financing. So the question in my mind is not always why venture debt, but why not venture debt?
ALAN 3:27
Understood. And in fact, if I'm not mistaken, 18 of the top 20 unicorns in the US have used venture debt. Is it mainly indeed to save equity dilution and grow valuations?
CHIN CHAO 3:38
Yes, that's the overarching theme. Venture debt provides a company with less expensive capital to grow and to achieve better metrics, so that they can reach higher valuations more quickly. And a company is able to do this while maximising the equity ownership of its shareholders, particularly the founding team. I think the practical use cases vary from company-to-company and business model to business model. For example, Tiki in Vietnam used venture debt from us for runway extension. Carsome in Malaysia used venture debt to finance inventory. Eruditus in India used venture debt for acquisition financing. And more particularly Indonesia, Akulaku used venture debt for loan book financing, and eFishery used venture debt to finance capital expenditures.
ALAN 4:18
Great. Well, can we delve a little more into how venture debt grows valuations? Paul, how does the use of venture debt grow valuations, and when does it not?
PAUL ONG 4:29
Well, it really depends on the growth metrics that companies use to value themselves. If a company focuses additional capital that it would otherwise not have, to better those metrics, they may stand a better shot at obtaining a better valuation. Also, valuation is always a negotiation and takes time. With more money in the bank, a founder may have more time to negotiate with potential investors on valuation comfortably; compared to a situation in which runway is low and you start to get nervous about getting a deal done. On the flip side, it possibly does not help grow valuations, and in fact, may impede valuation, if a company and its lender do not structure its loans responsibly, or ever company takes too much debt. For example, you want to make sure that you pay off your loans progressively as you spend your equity capital. Otherwise, you end up with a situation in which you have chunky liabilities which come to you at once. And this could put more pressure on the company to fundraise. And the company loses its leverage of time to negotiate a good valuation. For a lot of founders in Southeast Asia, it maybe their first time raising debt and it's a process that they are unfamiliar with. So it's the lender's responsibility to guide founders through the process and make sure that the amount of debt and how to subsequently paid it off, are manageable for the company; and that it puts the company in a better position, and not worse.
ALAN 5:46
That's a great explanation. Paul, what are the optimal criteria for the use of venture debt alongside VC equity investment? What is the ideal industry category? Cash flow profile? Growth trajectory?
PAUL ONG 6:01
Just a point of clarification here, Alan. Whilst it is true that we typically provide venture debt close in time to an equity round, it's not a requirement for us that it must come together with an equity around. In fact, in probably over 80% of our deals, we have provided venture debt in between equity financing rounds. What typically happens is that a founder reaches out to us three or four months after a round is closed, and says that business is growing better than expected, and that he or she needs additional capital to take advantage of opportunities that the company is seeing in the marketplace. The most critical criteria in my opinion is leverage. The amount of venture that is right for your company is a function of how much cash you have in the company; and whether or not you have comfortable runway to use that debt wisely. Based on us doing venture deals for 15 years, we believe that the right level of debt for a high growth, but still cash-burning company is typically 20% of its cash. You don't want to take too much and overload your company with too much liability. And a prudent lender will want to ensure that they don't provide you too much at the same point in time. You don't have to land-grab. Be patient. There will always be more opportunities to obtain loans as your company grows. There isn't an ideal industry category for loans in general. We've seen it used for everything from e-commerce to live streaming. But there are startup business models that lend themselves more naturally to the use of debt, such as B2B companies with receivable cycles, B2C companies with inventory requirements or even brick-and-mortar store footprints that come to mind. Loans to pre-revenue companies are also sometimes done, provided there is sufficient momentum and that founders are skillful and experienced enough to know how to manage that debt alongside their equity capital.
ALAN 7:43
So Chin, conversely, when should the entrepreneur not consider, or be wary of, the use of venture debt?
PAUL ONG 7:50
The first instance where venture debt doesn't make sense is for a company which is already at a low cash balance, or has a short runway, or when venture debt is used as a financing of last resort. The second instance where venture debt is not suitable is when the debt payments will amount to more than 20% of the company's operating expenses. As Paul mentioned earlier, we are careful not to over-leverage a company. As the loan size gets larger, loan repayments get larger, and it reaches a point where instead of being a benefit to the company, the loan repayments can actually become a burden to the company. So I think the 20% rule seems to work for us pretty well.
ALAN 8:27
Gotcha. So Paul, venture debt seems more nascent sent in Indonesia than in markets like the US. Why do you think that is?
PAUL ONG 8:37
Venture debt has always been a function of the maturity of the venture capital industry in a given market. And it's a product that also usually surfaces as a startup ecosystem matures. The venture market in Southeast Asia as a whole is a lot younger, and can be considered to still be in its infancy as compared to the US or even India, which are a lot more mature. So venture debt is a new concept to a lot of entrepreneurs in this region. And time is needed not just to educate the ecosystem, but for them to get comfortable with the idea. That being said, Innoven was the first regional player that introduced the concept to the ecosystem. And we have done good work in the region thus far to educate the market. And it's one of our missions to continue to educate. And as the Indonesian market and the rest of Southeast Asia continues to grow on the trajectory that it's on, we're confident that the use of venture debt will grow along with it. For example, what we've started to see in India in the last five years is that venture debt is now almost a part of every fundraise; that founders in India know how to build it into their rounds. We believe that down the road, Southeast Asia will be the same.
ALAN 9:41
So Paul, what elements of the Indonesia startup story itself makes the use of venture debt attractive to you, and what components of it might dissuade you from investing in Indonesia?
PAUL ONG 9:52
We're excited about the Indonesian market for all the same reasons as the VCs are: a large population with a young median age, a fast growing base of digitally savvy users, a government that supports the digitization of its economy, a growing number of success stories in tech within the country. And it's also a country that has historically grown many massive businesses, from consumer to finance. I don't believe that there's anything that has dissuaded us from investing in Indonesia. It's a market that we love. We've met many inspiring Indonesian founders who are mission-driven, and supported by many smart investors. Hence, it's definitely a focus market for us.
ALAN 10:31
So Paul, most VCs, when they're pitching investment into a start-up, claim to have a menu of value-adds. What types of value-add does Innoven commonly offer the entrepreneur?
PAUL ONG 10:42
So we don't see ourselves as an alternative to venture capital partners, but more of a synergistic partner to VC's and companies. Hence, whilst we are capable of many of the values that VCs offer, we prefer to bring something different and complimentary to the table. So on top of the common things such as opening doors and introductions, we try and plug our portfolio companies into the ecosystems of our anchor LPs Temasek Holdings and UOB Bank to find other opportunities to work together to grow the business, from potential future equity investments into a company to business partnerships with the bank. Having UOB as a partner also allows us to work with the bank to take over the working relationship with companies that have outgrown Innoven. And in those cases, you would then be able to provide the company with more tailored financing solutions, backed by the knowledge of a track record of working with Innoven.
ALAN 11:32
Gotcha. That's very helpful. Now Chin, how is diligence of a startup different for us than that of a VC investor? Does our focus differ at all relative to our VC peer?
PAUL ONG 11:45
We understand that the fundraising process is tiring. And usually companies have raised a round equity before looking at venture debt. And so the founders really want to get back to running the business. So first and foremost, we try to minimise the time drain on the founding team. So our process is typically shorter than a VC's due diligence process overall. As to what we specifically look at; we're looking at basically the same things that a VC will look at. And so the company doesn't typically have to create anything special for us. Whatever's in the data room from the last financing is usually good enough for us. Moreover, we take comfort in the fact that the VC's have already taken a close look at product-market fit, market size and competition. So our due diligence in these areas is lighter than the VC's. Where we probably differ is we probably take a more detailed look at the financials surrounding a company. We run various sensitivities to determine when the company may need to raise its next equity round. I think overall, the financial due diligence is just a little bit more intense. But otherwise, we're looking at basically the same things.
ALAN 12:47
Understood. Now, although we can't compare equity raising to debt raising on an apples-to-apples basis, we can say that equity dilutes founder shareholding, while venture debt might involve an interest rate of 10%-or-so. How should the founder think about this comparison?
CHIN CHAO 13:06
I always tell founders that if the company is growing by more than 20% per year, why would you sell a lot of shares to someone if those shares are going to be worth so much more even next year? You should instead take venture debt and pay some interest at 10% or 15% even, rather than sell shares that you know are going to be worth much, much more. As noted earlier, we've modelled it out, and the cost of debt can be 50 to 100 times cheaper than the cost of equity for fast growing companies. Another way to look at it is that the cost of equity is borne by the founders and existing shareholders. Because when you issue new shares, you're diluting existing shareholders, whereas the cost of debt is borne by the company itself. The founder and existing shareholders don't pay the interest. The company does.
ALAN 13:47
Gotcha. Now let's talk about the tenor or the length of time that the company has to pay back. What are the usual terms?
CHIN CHAO 13:54
The usual tenor varies on a deal-by-deal basis. But typically it can be anywhere from 12 to 30 months. And it also depends on geography. I think if you look at China, China loans are typically 12 to 24 months, whereas in Southeast Asia, we're typically between 18 to 30 months. And India is probably similar to Southeast Asia, and that's about an 18 to 30 month tenor.
ALAN 14:15
Gotcha. Now, Paul, since we last met, our investment in Southeast Asia tech at Innoven, and that in Indonesia, has mushroomed. Can you tell me what has happened in the past year that has led to Innoven being much more active in the region?
PAUL ONG 14:31
Personally, I think it was the convergence of two things: some Southeast Asian companies coming of age, as well as the pandemic that we're currently in. Sea Group's performance in the public markets in 2020 really held a torch for us. And then of course, the light at the end of the tunnel with respect to exits started to get brighter and brighter with the reemergence of SPAC's and the likes of Grab and GoTo announcing plans for listings, and then more recently Bukalapak. In the middle of that the effects of the pandemic have led to a pretty clear "K-shaped" recovery, with winners and winning categories becoming a lot clearer. I believe this had led to greater conviction around where capital is deployed, which has led to greater competition for good deals and hence larger rounds, faster deals and better valuations. All that is great activity for the region and attracts more attention. And certainly, it's a great time to grow a company in Southeast Asia right now.
ALAN 15:22
Makes a lot of sense. Gentlemen, can you share a successful case study of a company in the region that has successfully availed themselves of Innoven Capital debt, and gone on to do great things?
PAUL ONG 15:34
I think one of the success stories has been Akulaku. Whilst we at Innoven typically don't do pure loan book financing, we were one of the first institutional lenders to Akulaku at an earlier stage. Now that gave them additional capital to grow their numbers and the loan book, but also provided some momentum to open doors towards getting more institutional investors in for their loan book, and helped them grow to where they are today.
CHIN CHAO 16:00
The other company I'd like to mention is Carsome. We provided several venture debt facilities to Carsome beginning with its series A-2 round back in 2017. I think you saw the recent news that Carsome has become Malaysia's newest billion-dollar company. Carsome used venture debt to help finance its inventory. And also in this particular case, I always say Innoven served as a "bridge" between Carsome and traditional financiers such as banks. Carsome was able to build up a positive track record with Innoven, which they then used to secure additional facilities from traditional financiers such as banks.
ALAN 16:32
Now, Paul, how many transactions have we had Innoven done in Indonesia so far?
PAUL ONG 16:38
So we've done more than 20, across various industries and across everything from seed stage to Series C. And we're aiming for a lot more to come.
ALAN 16:46
So, what my 2023 look like in terms of focus on Indonesia, and potential number of deals done?
PAUL ONG 16:53
Well, we believe that there's so much growth potential in Indonesia with a lot of exciting companies being built currently by great people. Furthermore, I think the success of tech in Indonesia thus far could create new waves of entrepreneurs who have experiences working with the likes of GoTo and Gojek, and many others. And that whole cycle should grow as more and more window companies grow successfully. So I think the future is very bright for Indonesia, and that there are many, many, many more great companies that will be built. And we're excited to see that happen. I can't put a ballpark on the number of deals that we do. But I'm certain that we want to do as many as we can in Indonesia as the market continues to develop.
ALAN 17:30
That's really encouraging to hear. Gentlemen, thanks so much for coming together to join us today. I'm confident that we've enlightened much of our audience around the utility of venture debt, particularly in its ability to limit shareholding dilution to the entrepreneur as he or she raises funds, and also its ability to enhance valuations. Chin, thanks again for joining.
CHIN CHAO 17:52
My pleasure, Alan. Great being here.
ALAN 17:54
And Paul, thanks a bunch for coming on the podcast.
CHIN CHAO 17:57
Really appreciate your time Alan.
ALAN 17:59
We hope our listeners have enjoyed today's episode. As always, please consider sharing any feedback that you have about the Indo Tekno podcast with us. Terima kasih telah mendengarkan. Sampai jumpa lagi!