Promoters keen to guard equity are turning to private credit before IPOs

Mumbai: Promoters and founders of several companies are increasingly seeking private credit as an alternative to equity capital to tide over immediate funding needs ahead of a potential IPO (initial public offering), in a funding trend that the Reserve Bank of India says has grown fourfold in the past 10 years.

This is more the case with companies that are mulling public listing but need some more time to address current challenges before taking the plunge.

Promoters of such companies are heading towards the increasing number of private credit funds coming up to conserve equity ahead of IPOs, even as private equity funding has slowed and valuations are down post-covid, industry experts told Mint.

Significantly, private credit is growing despite high global interest rates because it offers flexible terms for pricing, duration, and structure. This flexibility helps companies manage their costs and cash flow more effectively in a challenging interest rate environment.

According to Nilesh Dhedhi, managing director and CEO of Avendus Finance, which provides private credit solutions, there are some instances where a company’s growth outlook is diminished due to temporary external factors, resulting in lower valuation. In such cases, he said, the companies can resort to structured private credit solutions for refinancing existing debt, or carrying out acquisitions and, thereby, delaying the IPO for a couple of years to achieve better value.

For instance, Avendus Finance had funded a specialty chemicals company that was planning an IPO in 18-24 months.

“When the company received a large order needing quick capital, traditional sources like banks and private equity would have been too slow,” said Dhedhi, adding that it was then the company turned to private credit. “Over the course of two years, the company was able to significantly scale up, nearly doubling its valuation by the time it approached the IPO market,” he added.

“We have witnessed companies and promoters using the instruments for family settlements, acquisitions, and getting over high-debt situations, amongst others,” said Munish Aggarwal, managing director head- equity capital markets, Equirus, adding that private credit is generally a non-dilutive instrument that allows companies to time their IPO once their challenges are addressed.

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“In the last 12-18 months, we have seen multiple pre-IPO transactions by private credit funds using NCDs (non-convertible debentures) and convertible instruments with equity-linked upside structures,” highlighted Vipin Singhal, director at Anand Rathi Investment Banking. According to Singhal, typical return expectation ranges from 14-18% across structures.

“Indian promoters are finding this more palatable compared to private equity expectations, timelines and, especially, with no need for immediate dilution. In most cases, companies are not required to provide board seats or similar rights,” he added.

However, private credit lenders such as alternative investment funds or AIFs are finding innovative ways of creating collateral including asset level security, sponsor pledges, and personal guarantees from founders and, thereby, protecting their downside risk, Singhal explained.

Pranob Gupta, managing director, credit alternates and CIO for JM Credit Opportunities Fund, JM Financial Asset Management, said, “With the Nifty up by ~29% in the last 12 months (and in general when underlying equity price performance is strong), it usually makes sense for promoters to conserve dilution (from private equity) and raise private credit now, and defer dilution to a later date.”

What is private credit?

Private credit bridges the gap between debt and equity, especially for firms eyeing an IPO. Offering greater flexibility than standard loans, structured private credit can include flexible moratoriums, varied coupon payouts, and specialized security arrangements. They are often used for purposes that banks either cannot or prefer not to finance.

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As in venture debt, which also lends to growth hungry businesses to meet their capital requirements and expansion plans, the repayment terms vary and in most cases the risk associated in both are perceived differently.

For venture debt, the vehicle is pooled from investors with the purpose of lending and has a defined fund life. But in case of private debt, the money comes from non-bank financing firms and lending to unlisted businesses is only one of the products.

Also, in private credit, it is more performing credit where coupons range from 14-19%, the risk is low and it is not so in venture debt.

The rise of private credit

According to the RBI, private credit has grown exponentially over the past decade.

“Private credit, which is essentially provided by non-bank lenders to corporates on a bilateral basis, has grown four-fold over the last ten years, emerging as a major source of corporate financing among middle-market firms that have low or negative earnings, high leverage, and lack of high quality collateral,” said Reserve Bank of India’s Financial Stability Report in June 2024.

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The report highlighted that private credit provides flexibility, swift execution, and greater confidentiality. For lenders, while these investments carry higher risks, they offer consistently superior returns, the report added.

Noteworthy private credit deals

In early 2023, Piramal Alt invested in Azad Engineering, timing the move with the latter’s IPO plans later that year. This wasn't their first rodeo; in August, they backed Harmony Organics, followed by Biodeal in April 2024, both with convertible instruments and clear IPO targets, according to industry experts who spoke with Mint.

Kotak Alt had a similar playbook, investing in TVS Logistics and securing an IPO exit when it happens.

Then, in May 2024, an AIF invested ₹400 crore in medical device manufacturer Biorad Medisys where the funds were used for capital expenditure and debt refinancing, with potential gains tied to a future equity event.

Edelweiss struck a $96 million deal with Biocon, creating a financing arrangement through equity-linked debentures. The deal guaranteed minimum returns in the early teens but also gave Edelweiss a stake in Biocon’s subsidiary, Biocon Biologics. Edelweiss’s return will be sealed when Biocon Biologics goes public, with the IPO slated for the first half of 2025.

Soumendra Ghosh, chief investment officer at Vivriti Asset Management, another private credit lender, explained that the flexible capital options enhance IPO prospects by allowing firms to secure bridge capital. This can help defer an equity raise if market conditions are unfavourable, support business growth, or provide an exit to shareholders without waiting for an IPO.

“We invested in a profitable B2B Saas firm, which was looking to hit public markets to raise capital for product development and grow existing product lines. Our capital helped the firm progress on its plans and improve the scale of its business and product portfolio before going to market. It allowed for time and strengthened the case for strong anchor participation. Eventually, about a year after our investment, the firm launched its IPO,” said Ghosh.

All said, high-growth small to mid-market companies with limited operating history should consider Venture Debt to fund growth and working capital needs, while highly leveraged companies operating at a loss or breakeven should explore Special Situations Debt for turnaround situations, explained Gupta of JM Financial Asset Management. He added that most private credit candidates can consider equity financing—whether private or public—as an alternative, but it's typically more expensive due to the higher cost of equity compared to debt.

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