Is Africa’s tech startup ecosystem ready for a debt financing boom?

Last year, 37 African tech startups raised a total of $767 million in 43 debt rounds, indicating the rise of the debt financing class and increasing global lenders’ confidence in African technology, according to Partech. report on venture capital financing in Africa.

“Africa’s tech ecosystem has set its sights on another asset class to help fuel growth,” the report said. “While debt funding remains largely under-reported and undisclosed, it is becoming increasingly important in the fundraising strategy of African startups.”

This is the first time that Partech will report on debt in its annual report. According to its findings, Nigerian startups raised 45% or $345 million of total registered debt, the fintech sector accounted for over 54%, and there were 34 unique debt investors, with Lendable and IFC being among the most active.

” As the [African tech startup] the ecosystem matures, more companies will do a combination of debt and equity [funding rounds]said Dare Okoudjou, CEO and Founder of MFS Africa in October 2021. Okoudjou’s statement came after the pan-African fintech giant shut down a $100 million Series C funding round – split between $70 million in equity and $30 million in debt.

Most startups looking to raise capital in their formative years typically consider equity, which requires founders to give up stock in their company in exchange for capital. At this stage, the business is extremely risky and therefore does not use most financing options (such as debt which requires repayment on an agreed date with interest) except venture capital.

“Debt investors typically seek predictable cash flows or transferable assets (such as real estate) to back their exposures. For most startups, those two things are rare,” Rahul Shahhead of financial equity research at Tellimer, told TechCabal in an interview.

Since the majority of startups are at an early stage, debt takes up a small share of the larger private tech funding market. According to Ayobamigbe Teribaa former analyst at Ingressive Capital, debt financing is viable for businesses but tricky.

“A lot of [early-stage] companies don’t consider it [debt] because of the criteria related to their access, which are different from equity,” he said. “While this allows founders to retain ownership, the access criteria can be more cumbersome than equity financing which has been the anchor in the ecosystem and is based on the stages of startups.”

But as an ecosystem matures and growing startups choose to remain private longer, funding alternatives like debt become viable and interest increases. “As startups grow and achieve some predictability, debt financing can be a useful instrument,” the Partech report notes. “It helps accelerate growth while limiting the dilution of seed rounds.”

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There is no data available on the amount of debt that African startups have attracted over the years. But several funding announcements last year – when venture capital funding in Africa hit the $5 billion— suggest that 2021 has seen an acceleration in serious appetite for debt financing. Outside of MFS Africa, move, trelleand TradeDepot are some of the startups that have announced debt rounds.

Because the ecosystem is at a stage where additional funding is needed for many fast-growing startups, more debt funding announcements should be expected this year, predicts Kunle Akinolainvestment analyst at Platform Capital, a Lagos-based private equity firm.

“Africa hit 5 new unicorns in 2021, which indicates growth. As a founder of one of these companies or another growth-stage company, you probably don’t want to issue shares unnecessarily for finance acquisitions or capital expenditures during growth and expansion,” Akinola said.

The Partech report further notes that strategic debt players have launched debt funds dedicated to emerging markets – particularly Africa.

Last October, emerging markets-focused lender Lendable announced a plan to raise a $100 million fund targeting African and Asian fintech companies. He participated in MFS Africa’s $100m funding round with $30m debt and has backed numerous startups in Africa.

Development Finance Institutions like UK CDC, Dutch Development Bank and IFC are also leaders in this financing segment. The latter has so far deployed debt to support TradeDepot, Bolt, Kobo360, and more. “I expect a major increase in debt deployment by existing players and new entrants alike,” Teriba said.

With the growing rise in debt financing activity in Africa, which companies are best suited for the financing option?

According to Rahul Shah, industries with debt-friendly assets or business models have a better chance of accessing this source of funding. “For example, financial companies looking to fund their loans, particularly where they can demonstrate strong risk management to reduce repayment cash flow uncertainty,” he said.

In the case of MFS Africa, it raised debt financing to fund the floats needed for real-time settlements. “We realized we don’t need to raise capital because there is a debt market for that,” the CEO said at the time.

Another emerging sector with access to debt financing is renewable energy: physical infrastructure (such as solar panels) and supply contracts can give debt investors the assurance that they will be repaid. In this space, West African-focused solar providers like Starsight and Daystar Power have leveraged debt heavily to fund their operations.

“In such cases, debt financing may make more sense than equity financing; asset and liability cash flows are better matched and shareholder returns can be enhanced,” the Tellimer manager said.

Short-term debt financing is also available if backed by inventory; for example, e-commerce retailers and their suppliers. In contrast, companies with non-transferable intangible assets (such as early-stage biotechnology) would likely struggle to secure debt financing.

Essentially, debt depends on the cash flows or revenue patterns of businesses. Once models become reliable and product-market fit is emphasized, debt investors become more open to funding a startup.

Based on the current trend, Africa is poised to witness an increase in the number of founders seeking debt funding for their startups in the coming years.

“We are starting from a very low base; in that sense, the volumes can only increase from here,” Shah said. “As the current cadre of African startups matures, they will become more attractive to debt investors given that they have a demonstrable track record. And as startup debt investors on the continent gain experience, their risk appetite will improve.

Teriba adds that more startups are likely to engage capital markets, institutional lenders for credit to “expand and stabilize their business offerings.”

While near-term growth prospects are strong, a major medium-term headwind is the global cycle of monetary tightening as developed countries, where most of the funding for African startups comes from, roll back monetary measures intended to help businesses overcome the COVID-19 pandemic.

“The era of cheap and plentiful money is coming to an end, and this will eventually limit end investors’ appetite for riskier forms of debt,” Shah added.

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Carol M. Barragan