Next Wave: Venture debt’s role in Africa’s startup ecosystem

Africa’s startup ecosystem has faced challenges in recent years, with some running behind their fundraising targets while others have been forced to lay off or close. The distressing scenario is attributed to a decline in VC deals since 2022, and a tough macroeconomic environment that has seen a slowdown in economic activity. In 2023, the global VC market fell 35% year-on-year, the lowest in four years. African VC deals decreased by 31% year-on-year, according to African Private Capital Association data. With investment slowing, experts are divided on the future of venture debt, as founders seek alternatives to equity financing which has been the darling of the ecosystem.

While equity financing remains the go-to for African startups, venture debt is gaining traction because of its unique value proposition. It gives startups the working capital they need to scale operations, but without diluting ownership. This has given early-stage firms a lifeline, considering access to conventional debt in most African countries can be limited. However, the recent upheavals that have seen startups like Kenya’s Sendy, a B2B logistics firm, and Copia, a B2C e-commerce platform, close and enter liquidation have sent panic over the future of VC debt. VC analysts observe that firms that entered administration did not have enough recoverable assets to settle creditors. However, this cannot be a problem for VCs with robust risk assessment models and strong local partners like banks and microfinance institutions.

VC funding to African startups from 2019-2023 (in USD millions)

The African debt market is still relatively nascent, compared to its global peers, with limited data and credit history making it hard to secure funding. Venture capitalists trying to navigate this without much support from local lenders who have the infrastructure are bound to face challenges. Big African banks like South Africa’s Standard Bank, Nigeria’s Access Bank and Kenya’s Equity Group, have all developed asset-backed and revenue-based lending models that VCs can borrow or rely on if they build local partnerships. Accurate credit risk assessment is required to evaluate startups’ creditworthiness in a region where financial data is scarce; local banks have made progress here.

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A growing number of African tech startups are reaching a later stage, requiring larger funding rounds. This will allow lenders to create more structured debt products. Limited success stories to look to have made it hard to project the future of venture debt, experts say. Like other regions, some tech innovations have failed to pick up after receiving millions in VC backing. Those who borrowed have failed to repay the loans after struggling to make profits. With more startups hitting maturity, lenders will have historical data to determine companies’ creditworthiness.

As the debt component gains traction, analysts say local players, including VCs, will come up with technological solutions to assess, underwrite and manage venture debt. Additional capital can help startups expand, develop new products, and increase marketing efforts. Therefore, the ecosystem will find solutions to respond to the hurdles stopping alternative financing.

VC investment in African tech by category from 2019-2023 (in USD millions)

Founders also have a role in ensuring venture debt remains a viable financing option. The challenges that have faced the African tech ecosystem have offered valuable lessons. To secure more funding options including debt, startups will need to have a clear revenue generation plan to return investors’ money and manage debt repayments. This will be achieved by building strong financial models that demonstrate clear paths to profitability and repayment. With this, lenders will not hesitate to close large-size funding deals with promising innovations. In addition, startups will allocate borrowed funds to well-thought programmes to increase impact and return on investment. The narrative of founders misusing investors funds has been persistent, but as the market matures most startups are keen on sustainable growth.

The fast-paced approach to startup growth has been termed as their greatest flaw. Pressure from investors has been blamed for the collapse of some of the promising innovations like Sendy, Copia, and iProcure. Typically, VCs put money in startups with high growth, but push for short-term returns. Despite the challenges, experts believe that venture debt will play a greater role in the growth of African startups in the coming years. As the market matures, increased competition among lenders and more diverse solutions will see larger deal sizes. For founders, understanding alternative fundraising to equity financing will be essential for optimising their capital structure and accelerating growth.

Adonijah Ndege

Senior Reporter, TechCabal

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