Smaller businesses are facing a problem. They want to pursue interesting ideas and need money but banks are stricter with sanctioning loans. The window of opportunity is fast closing and many businesses are hurting for funds. This is the niche that IAS Balamurugan, Managing Partner, Anicut Capital LLP, which manages Grand Anicut Fund Trust, hopes to tap with its new alternate investment debt fund. Excerpts from an interview:

What is the rationale for the fund launch?

The fund will provide high-interest debt to SMEs in various verticals. For example, it could be used to acquire businesses or other assets through M&A; expansions that they want to move quickly on and infuse equity when valuations increase. It can also be to raise cash quickly against sale of non-core assets which may take time to dispose of.

There are also cases where founders want to give PE funds, which had invested a while back in them, an exit. They want to buy back shares and increase the promoter ownership. We also expect to invest along with PE funds (and in between two equity funding rounds also) when the business seeks capital infusion and prefers a mix of equity and debt.

The funding need in the SME sector is huge; schemes such as Mudra are addressing the smaller ticket ones. There is room for many kinds of loan products – different tenure, terms, risk profile — as the needs are varied and growing.

Are there any sector preferences?

All we look for is what any debt provider considers – the business must be cash positive and there must be a way to service the debt. We are sector agnostic and there are opportunities in varied sectors such as health, food retail, pharma and manufacturing. We do not plan to invest in real estate sector.

What are the loan terms for a borrower?

The terms are flexible with interest payment being monthly or quarterly and principal repaid as a bullet payment. The loan tenure is typically 18 months but it is variable. For instance, it can be in a window of 18 to 24 months or based on an event such as fund raising. We also provide the option of getting 20 per cent warrants as a way to gain from additional upside. This is, however, only planned for 10-20 per cent of the deals.

Why would SMEs borrow at a high rate of interest?

Businesses look at opportunity cost of an investment. Banks only provide working capital or asset purchase loans and do not offer event-based lending. So the main source of SME funds is from the unorganised segment. The situation is similar to the structure that micro finance institutions brought to the small ticket loan to individuals. We hope to increase organised lending in the ₹10-30 crore SME loan segment.

Also, while we gauge, mitigate and monitor risks, there are macro level risks such as a down cycle when the repayment is due that may limit the company’s ability to raise new funding. So the lender has to be compensated for the risks they take.

Going by banks’ experience on corporate lending, how do you mitigate default risks?

Private placement to SMEs is something we have done for a while; about ₹450 crore have been deployed with zero defaults.

The key is eliminating fraud and this is done through multiple reference checks – vendors, customers, investors, previous track record. The promoter’s ability to scale operations is also gauged as it influences repayment capacity.

We also use a basket of collaterals that include hard real assets, at least 26 per cent of company ownership, family member commitments and at times intellectual property.

The aim is to have enough deterrents to avoid defaults through such a wider cover. We have early warning systems where we monitor key developments.

Who may be other players offering such a product?

Most of the debt market is corporate bonds that have good credit rating. High-yield funds typically operate in distressed assets segment where they bet on a turnaround.

There is also venture debt where the returns are expected to get a kicker from warranties that convert to equity.

What is the attraction for investors?

We are seeing a good response from investors — we have commitments for ₹110 crore in three months. One, many investors are business owners who understand the need for such a short-term loan product. Two, they see it as a diversification from other asset classes such as equity and real estate structured debt products. Three, the short tenure and regular quarterly cash flow are attractive. Being a debt product there is better return visibility and the strong obligations to repay the loan increases the certainty of fund exit.

What are the terms of the fund?

This is a closed ended high-yield debt fund with four year tenure. We hope to earn an IRR of 22 per cent primarily through interest received. Management fee is 1.5 per cent. The fund size is ₹250 crore and minimum investment size is ₹2 crore for individuals and ₹20 crore for institutions. The aim is to invest the fund 2-2.5 times during the fund tenure. Principal may be paid back from the third year. We also pay out interest every quarter.

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