For entrepreneurs, every penny matters, and managing finances efficiently can make or break a venture. While securing investments is a crucial milestone, the real challenge lies in making the most out of these funds.

In today’s KOFFi Break, we will discuss how entrepreneurs can leverage debt funds to optimise these resources to efficiently manage the finances of their startup. 

Understanding Debt Funds

Debt funds are the type of mutual fund that only invests in fixed-income securities like bonds, treasury bills, commercial papers, and money market instruments. 

Debt funds offer relatively stable returns, with high liquidity, and a low-cost structure compared to other fund parking options.

These funds are considered lower risk compared to equity funds, as their major assets are allocated into high-quality fixed-income instruments.

The debt fund’s major assets are allocated to government securities, corporate debt, and bonds. Fixed interest earned on these securities is usually added as dividends at the end of the day, which is mainly responsible for how a debt fund’s NAV(net asset value). So looking into the funds portfolio you’ll get an idea of future returns, risk, and liquidity.

Why do entrepreneurs Opt for Debt Funds?

Most of the entrepreneur would like to raise capital for their venture to help it scale. However, raising funds is not enough for growth; as an entrepreneur, you must ensure that you make the most out of your available capital resources. 

It starts with where you park your capital so that it is easily accessible when needed, in a safe place, and can generate returns in the meantime which eventually boosts your startup runway. Debt funds can be an ideal option for parking your startup’s capital.

Let’s Understand the Benefits of Debt Funds in Fund Parking

1. Safety: Debt funds only invest in quality debt instruments like government securities, money market instruments, and corporate bonds which make it a low-risk or fixed-income instrument. 
   
   
2. Steady Capital Appreciation: Debt funds offer a stable return compared to the volatility of equity markets. This stability allows founders to predict cash flow more accurately, which is crucial for effective budgeting and financial planning.
   
   When you know what returns to expect, it becomes easier to allocate resources and plan for future expenses.
   
   
3. Liquidity: One of the key benefits of debt funds is their liquidity. Funds can be accessed relatively quickly when needed, ensuring that the startup has the flexibility to cover short-term operational costs or take advantage of sudden opportunities.
   
   This liquidity is essential for maintaining smooth business operations without the risk of cash flow shortages.
   
   
4. Higher Returns Compared to Current Accounts: Unlike traditional savings accounts, which offer minimal returns, debt funds typically provide higher yields. This means that the money raised through investments can grow more efficiently, providing additional runway to entrepreneurs. 

Let’s Try to Understand in More Detail With an Example 

Consider you are a startup founder who raised $2 million in a Series A round which provides you a runway of 20 months. You planned to use this capital over the next 2 years to expand and hire new talents.   

Now you have $2 million in your bank account, which you plan to use in the next 2 years. However, that capital is currently sitting idle in your account with a zero interest rate, losing its potential,

So, you decided to park this capital into debt funds for better returns, high liquidity, and safety. 

Let’s Calculate How Much Additional Runway You Will Have After 20 Months. 

Let’s assume that $2 million will give you a runway of 20 months which means your startup probably will have a monthly burn rate of $1,00,000. 

This brings you to withdraw $1,00,000 per month from $2 million parked in a debt fund where you get a stable 7% returns p.a. 

Now let’s break down the calculation step by step:

Assumption: 

• Initial Fund Parked: $2,000,000 ($2 million)
• Monthly Withdrawal: $1,00,000 ($ 100k)
• Annual Return Rate: 7%
• Monthly Return Rate: (7%)/12 = 0.5%
• Duration: 20 months

The starting balance of each month is the ending balance from the previous month. 

Each month, you withdraw $1,00,000 and then calculate the interest on the remaining balance.

Let’s proceed with the iterative calculation:

1. Month 1:
   • Starting Balance: $20,00,000
   • Withdrawal: $1,00,000
   • Remaining Balance: $18,00,000
   • Interest Earned: $18,00,000 * 0.5% = $9,000
   • End of Month Balance: $18,09,000
     
     
2. Month 2:
   • Starting Balance: $18,09,000
   • Withdrawal: $1,00,000
   • Remaining Balance: $17,09,000
   • Interest Earned: $17,09,000 * 0.5% = $8,545
   • End of Month Balance: $17,08,545

… continue this process for each month up to Month 20.

After 18 months of withdrawals and interest accumulation:

• Remaining Balance: $1,19,581
• Total Interest Earned: $1,19,582

As an entrepreneur, you will get a month’s additional runway without doing much and utilise this additional capital which was otherwise not possible with the bank’s current account

Final Thought

By leveraging debt funds, entrepreneurs can ensure that their funds are not just sitting idle but actively contributing to the business’s growth. This strategic financial management can make a significant difference in a startup’s success, providing the necessary resources to innovate, expand, and thrive in a competitive market.

So, if you’re a startup founder looking to optimise your financial management, consider debt funds as your next strategic move.