The landscape of funding for African startups has been evolving in recent years, with debt financing becoming an increasingly popular option. While venture capital investments have seen a decline, debt financing has been on the rise, accounting for 18% of total startup funding in 2024. This shift towards debt financing offers startups a faster route to capital, allowing them to meet immediate business objectives without the need for raising equity at unfavourable valuations.
One key advantage of debt financing is that it helps startups avoid excessive dilution, ultimately positioning both founders and investors for stronger exits when opportunities arise. However, debt financing is not suitable for every startup. In a recent conversation with Techpoint Africa, Patrick Igwe, Fintech Business Officer at FSDH Merchant Bank, highlighted the key characteristics that make a startup a good candidate for debt financing.
According to Igwe, startups must have matured to a certain level before seeking debt capital. Early-stage companies should focus on securing equity rather than taking on debt that could destabilize their business. Debt financing products vary, including invoice financing, contract financing, and termed loans. It is important for startups to seek affordable debt financing, considering the high interest rates in Nigeria.
In Nigeria, there are various types of lenders active in the market, including development finance institutions (DFIs) and financing institutions that provide debt capital off their balance sheets. Startups looking to access debt financing need to have at least three years of audited financials, updated management accounts, and one-year bank statements. Depending on the type of debt financing, lenders may also require invoices or contracts.
Founders often make mistakes when seeking debt funding, such as not having their financials in order or working with unreliable auditors. Lenders assess creditworthiness by checking the track record of the business, analyzing financial position, and understanding the market potential. While startups may be asset-light, lenders may still require collateral as security for the debt.
In conclusion, debt financing has become a viable option for African startups looking to scale their businesses quickly. By understanding the requirements for debt financing and working with reliable partners, startups can access the capital they need to achieve their growth objectives while minimizing risk. Startups often overlook hidden risks and costs when signing loan agreements, which can have serious consequences. One common risk is turnover covenants, where the lender sets a minimum turnover requirement that the startup must meet. Failure to meet this requirement can result in the lender recalling the credit facility or refusing to extend future credit.
It is crucial for startups to carefully read and understand the terms of the loan agreement before signing. If there are any terms that are unclear, it is advisable to seek legal advice to ensure that all risks are properly assessed.
The timing of when startups should consider different types of financing depends on their specific goals and needs. For example, invoice financing is suitable for trade businesses looking to import or export products, while term loans or working capital loans are more appropriate for startups in need of immediate cash flow.
While startups can negotiate the terms of their financing agreements to some extent, there are limits to their bargaining power. Lenders typically have minimum interest rates that they cannot go below, such as the monetary policy rate (MPR). However, in some cases, banks may offer concessionary or intervention funds that allow for lower interest rates.
It is recommended for startups to involve lawyers early in the debt financing process, especially as they scale and grow their businesses. Legal advice can help startups navigate the regulatory environment and ensure compliance with laws and regulations.
If a startup discovers that it may be unable to repay a loan, it is important to communicate with the lender as soon as possible. Many financing houses have policies in place to address delinquent loans, and a relationship manager may be able to work with the startup to find a solution before the situation escalates.
In conclusion, startups should be aware of the hidden risks and costs associated with loan agreements and seek legal advice when necessary. By carefully evaluating their financing options and understanding the terms of their agreements, startups can mitigate risks and ensure the long-term success of their businesses.
