Venture Debt

A founder who needs another Rs 25 crore has a bad choice. Raising equity means selling more of the company, and if the last round was priced optimistically the next one may be priced lower — a down round, which resets everybody's stake.

Venture debt is the third option. It is a loan, so it does not dilute. It is expensive, because the borrower is a start-up with no assets and no profits. And it is available only to companies that have already raised institutional venture capital equity — the lender is not underwriting the business so much as underwriting the judgement of the equity investors who came before it, and their willingness to fund the next round out of which the loan gets repaid.

The AIF Regulations do not treat venture debt funds as a separate category. They sit inside venture capital funds.

The shape of a venture debt facility, from Chapters 2 and 11:

• Tenor: 2 to 3 years, a contractual maturity date, which is the first of the three advantages the workbook lists over venture equity.
• Repayment usually comes out of subsequent rounds of equity financing rather than out of operating cash flow.
• Security: typically unsecured — these are asset-light businesses — though a facility often takes shares or other collateral, which is the second advantage.
• Ranking: senior to the equity in the capital structure, the third advantage.
• Pricing: above normal commercial loan rates, to carry the higher risk.
• Equity kicker: usually up to 10% of the loan amount, taken as warrants or conversion rights at an agreed valuation. If the company's valuation rises, the conversion clause is an in-the-money option for the lender.

Where it gets used: spikes in cash requirement at a high-growth company without further equity dilution; bridge financing when the next equity round is delayed or a down round threatens; and filling the debt gap for companies that cannot post the collateral a bank requires.

The risk is specific and it is not credit risk in the ordinary sense. It is insufficient or negative cash flow at the borrower. If the company's fortunes turn, the lending AIF is left holding founder shares in a distressed, unlisted company — collateral that cannot be sold, so the loan simply goes sticky.

On the market: as of 2025 venture debt is only 8 to 9% of Indian venture capital financing, so the workbook treats it as under-penetrated. Structures can yield IRRs of over 25 to 30% to lending funds, though the private credit market moderated considerably in 2024-25 as more funds arrived.

Some funds that call themselves venture debt funds are really doing mezzanine financing of growth-stage venture capital undertakings — debt with an equity upside, warrants attached. Pure venture debt funds also exist, lending at above-market rates to high-growth start-ups that are already venture-equity funded.

Kestrel Venture Debt Fund I, a Category II AIF, lends to a logistics software company that has just closed a Rs 120 crore Series B at a Rs 600 crore post-money valuation.

Terms

The kicker, sized

Warrants                Rs 2.5 cr at a Rs 600 cr post-money
Stake acquired          2.5 ÷ 600  =  0.4167% of the company

If it works. Eighteen months later the company raises a Series C at Rs 1,800 crore post-money — three times the Series B — and the loan is repaid out of it.

Interest   Rs 25 cr x 15% x 2 years          =  Rs  7.50 cr
Fee                                          =  Rs  0.25 cr
Warrants   0.4167% x Rs 1,800 cr             =  Rs  7.50 cr
  less exercise cost                         =  Rs (2.50) cr
                                             ─────────────
Total return on Rs 25 cr over 2 years        =  Rs 12.75 cr
Money multiple                               =  1.51x

About 23% a year on a simple annualisation, and higher on an IRR basis because the interest arrives monthly rather than at the end — which is how the workbook's 25 to 30% band is reached.

If it does not. The Series C never comes. The company runs out of cash at month 20 with Rs 25 crore of principal outstanding. The security is a pledge over founder shares in an unlisted company nobody wants to buy, the warrants are worthless, and the fund holds a sticky loan against an asset with no market. The equity investors who came before Kestrel have already written their position to zero — and it was their conviction, not the borrower's balance sheet, that Kestrel was really lending against.

Chapter 2 (Types of Investments), section 2.3.1 introduces venture debt alongside venture capital; Chapter 6 places it inside the private debt market; Chapter 11 (Investment Strategies, Investment Process and Governance of Funds), section 11.1.2 covers it as investment strategy 9, with the three advantages, the equity kicker and the return band. Expect a recall question on the equity kicker being up to 10% of the loan amount, on the 2-to-3-year tenor, and — most often — on the fact that the AIF Regulations do not give venture debt funds a category of their own.

• Venture debt funds are not a separate AIF category. The AIF Regulations treat them as part of venture capital funds, which sit under Category I.
• It is lending to companies that have already raised institutional venture equity. A start-up with no equity backer is not a venture debt borrower; the prior round is the underwriting.
• The equity kicker is up to 10% of the loan amount, not 10% of the company and not 10% of the equity round.
• Repayment comes from the next equity round, not from operating cash flow. That is why a delayed or failed round is the real default trigger.
• Unsecured does not mean uncollateralised. Facilities often take founder shares or other collateral; the point is that there is no asset base to secure against in the way a bank would require.
• It is senior to equity, not senior to bank debt. In companies with banks as senior lenders, private credit generally sits subordinate — venture debt is senior only within the start-up's own thin capital stack.
• Mezzanine financing with warrants is not the same product, even though funds doing it often use the venture debt label.