More competition in the venture debt space as banks enter the arena

VENTURE debt in South-east Asia got a boost recently with a tie-up between early stage incubator and investor Antler and HSBC.

The tie-up brings access to HSBC’s venture debt offering, among other banking services, to Antler’s portfolio companies.

“This collaboration is a natural extension of our long-standing heritage of supporting entrepreneurs and scaling businesses,” said Amanda Murphy, head of commercial banking, South and South-east Asia, HSBC.

Besides the Antler tie-up, HSBC also has a US$200 million New Economy Fund in Singapore, launched in November 2021, and has supported 20 startups so far. In September 2023, HSBC launched a RM500 million (S$143 million) New Economy Fund in Malaysia to support tech-led businesses and Series B and beyond startups.

Venture debt has recently gained popularity among startups in the republic, fuelled by the pullback in funding in the early stages of the pandemic. Venture financing typically consists of a loan, as well as a warrant for the right to purchase equity in the startup at a discount to the next round of funding.

The three local banks have made moves into venture debt, via an Enterprise Singapore (EnterpriseSG) scheme. Launched in 2016, the Enterprise Financing Scheme is eligible for companies registered and operating in the republic with at least 30 per cent stake held by a Singaporean or permanent resident.

Subject to each bank’s credit assessment, EnterpriseSG shares up to 70 per cent of the risk of defaults for eligible companies.

“It is still one of the best kept secrets – you don’t hear a lot about the programme in the market,” said Iris Ng, head of middle market for global commercial banking at OCBC.

DBS sees a gap that banks could fill in supporting growth-stage companies via venture debt. UOB declined to comment for this story.

“Banks can support early-stage companies with structured working capital-related debt, which often includes operational integration with the startups and greater hand-holding in the development phase,” said a DBS spokesperson.

As OCBC pointed out, the venture debt space is still very nascent for banks in Singapore. Lenders avoid taking illiquid assets such as startup equity as collateral for loans. But the EnterpriseSG programme provides a unique opportunity for the bank to learn about new ways of supporting young ventures.

A recent tweak to the EnterpriseSG Venture Debt programme allows a startup to issue redeemable convertible preference shares (RCPS) as collateral. This was a move that OCBC had been pushing for over the last two years, as a way to give flexibility to startups and not take money off growth or expansion plans.

“RCPS gave that flexibility ... it is a quasi-debt instrument and companies pay dividends instead of interest,” said Ng.

Another potential benefit for startups using RCPS is that the bank providing venture debt will become a shareholder. This does give some reputational benefit for the startup, noted Ng.

Startups are catching on. OCBC closed a venture debt deal within three months of the launch of the RCPS option.

As at 2023, OCBC has a portfolio of more than 50 companies under the EnterpriseSG scheme. DBS and UOB declined to share any numbers.

Frenemies

While startup financing can be risky for banks, building relationships with emerging companies lays a pipeline for their future banking needs.

Apart from banking support, financial products offered – such as working capital loans, structured finance and asset-backed solutions – give banks an edge. HSBC’s Murphy said the banks can offer tailored solutions as well as strategic help across multiple markets.

“This is a clear advantage we have over deal-specific specialist debt funds as we can be more competitive on pricing and structure by looking at the overall relationship,” she added.

Venture debt providers said they welcome the entry of banks into the space. Banks can lend at quantums that venture debt providers cannot, and are coming in with different objectives.

“They hope to capture the next rising star, which is a slightly different proposition than us. Their risk appetite is also different because banks are a regulated institution, which can’t take that much risk,” said Ben Cheah, partner at venture debt provider Innoven Capital.

Venture debt providers also want their portfolio companies to graduate from their debt, and banks are the next institutions for companies to take debt from.

While banks might offer more services and options, how they maintain relationships could make a difference to startups. According to venture debt providers, teams in banks rarely stay the same, and a startup is likely to continually see fresh faces dealing with them.

“We need to be there for the companies; and when the banks see us coming in, they also get more comfortable,” said Jeremy Loh, co-founder and partner, Genesis Alternative Ventures. Having venture debt providers on the cap table provides some vetting of the company and validation of the company’s potential.

Venture debt providers also see banks as partners in future rounds of venture debt funding, where they can work together towards a deal.

“Banks coming in are welcomed. It is more validation of what we are doing and gives our companies pathways to graduate, and gives us more people to work with,” said Innoven Capital’s Cheah.