Priority lending tag to provide new credit lifeline for young startups

But banks need to understand high growth business model of the ecosystem and how to underwrite them, says industry

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Banks | Start-ups | Coronavirus

Ever since the Covid-19 pandemic hit the country, Prakash Kumar, an IIIT graduate and founder of startup KhaaliJeb has been making the rounds of offices of venture capital (VC) firms to raise funds for his bootstrapped banking app for the youth. He has been turned down by 10 VCs so far.

“Pre-2016, a lot of young startup founders were raising funds, but now the trend is that new startup founders are finding it difficult to raise funds. Most of the funds are being raised by second time founders, or those with a corporate trail,” says Kumar, who has been bootstrapping KhaaliJeb for two years now.

Particularly in India, many startups are only funded if they have founders from the IITs of the world, say players. “Perhaps, many fresh ideas don’t come from the IITs and it becomes difficult for such ventures to see the light of the day,” says Ashok Kadsur, co-founder of SignDesk, a digital start-up which is in the process of raising its first funding.

These companies now see hope with the Reserve Bank of India including start-ups in the Priority Sector Lending (PSL) group. This announcement opens new avenues to raise capital for young startups and would help them raise funds.

“This opens up a new avenue of capital, especially in the early stages when many founders struggle to convince a small pool of investors to raise Rs 50 lakh to Rs 1 crore to start their companies and they have limited sources other than friends and family,” says Anup Jain, managing partner, Orios Venture Partners.

There have been instances in the past when start-up founders have had to even mortgage their houses to avail loans from banks.

So PSL at 8-10 per cent by walking into a bank is a dream for a startup founder as compared to expensive debt available from VCs.

According to Tracxn, funding activity in the startup ecosystem decreased by 29 per cent to $4.2 billion in the first six month of this year when compared to $5.9 billion in the same period last year, due to the impact of the Covid-19 pandemic. Only 443 companies were funded in the January-June period this year as against 725 in the corresponding period of last year.

Segments such as IoT and healthcare would certainly gain from this step by RBI, according to Sanjay Swamy, managing partner at Prime Venture Partners. However, others in sectors like stock markets and trading might not be considered by banks as these sectors are seen as a speculative activity.

“Procuring an unsecured or a secured loan looks highly implausible because of this outlook. It really depends on where the startups operate. All startups can’t be painted with the same brush. Asset-heavy businesses such as renewable energy may get more preference here,” says Tejas Khoday, co-founder and CEO of bootstrapped brokerage startup Fyers.

This development also comes with some riders as borrowing from banks comes with its own set of risks. Banks will have to understand high growth business models of the startup ecosystem and how to underwrite them.

Start-ups have to be sure of their model and profitability because taking capital from banks is a lot of risk. Unless I am sure that I will be able to pay back that debt, it will be difficult for me to go there,” explains Kumar of KhaaliJeb.

The priority lending tag could also help India become self-reliant in start-up funding. Out of the nearly $14 billion raised by startups from VCs in the year-ending, roughly only $1 billion came from Indian sources. “Now, banks and financial institutions participating will unleash rupee capital into the ecosystem. We may become self-reliant in terms of startup funding than being completely and inordinately reliant only on foreign capital and external funding due to regulations,” said Siddarth Pai, founding partner at early-stage VC fund 3one4 Capital.

“There are enough debt funds overseas and a few in India too, that have come up over the last 4-5 years and we strongly feel that it will open up more opportunities for debt funds as well,” said Ashish Fafadia, partner at early stage VC Blume Ventures.