Why African Startups Are Turning to Venture Debt Over Equity

NAIROBI — African technology and fintech startups, facing a significantly tighter equity funding environment than they experienced during the boom years of 2019 to 2022, have turned with growing enthusiasm to venture debt as an alternative or supplement to equity capital raising. The shift represents a meaningful evolution in how the continent’s most promising growth companies think about capital structure, reflecting both the practical constraints of a period when equity valuations have compressed and investor selectivity has increased sharply, and a genuine maturation in the sophistication with which startup founders and their advisors approach capital allocation and dilution management.

Venture debt — loans extended to startups and growth-stage companies, typically backed by a lien on assets and structured with warrants or other equity participation rights for the lender — has long been a staple of startup financing in the United States and Europe, where dedicated venture debt funds and specialized bank lending units have operated for decades. In Africa, the instrument has historically been less accessible, constrained by limited lender familiarity with startup risk profiles, limited track records among African startups in managing structured debt obligations and a smaller ecosystem of specialized lenders with the risk appetite and technical capability to underwrite growth-stage company loans in African market conditions. Each of these constraints has eased meaningfully over the past several years, driving a notable expansion in the volume and variety of venture debt available to African companies.

The growth of dedicated debt facilities for African startups has been supported by several international development finance institutions that have recognized the instrument’s role in extending the impact of equity capital already invested. A company that has raised equity and is deploying it for growth can, with an appropriately sized venture debt facility, extend its operating runway without issuing additional equity at potentially dilutive prices, preserve equity for a future fundraise at a higher valuation that better reflects the progress made with the initial capital and use debt specifically for asset-backed deployment — financing a portfolio of loans, for instance, rather than funding operating costs — in a way that creates the strongest case for debt capital rather than equity.

Fintech companies have been the most natural users of venture debt in African markets, for reasons rooted in the specific economics of lending businesses. A digital lender or BNPL provider whose core business involves extending credit to end borrowers needs funding for its loan portfolio that, in economic terms, is most efficiently structured as debt — matching the nature of its assets. Funding a portfolio of consumer or small business loans with equity is expensive: equity capital is more costly than debt and carries investor expectations of returns calibrated to equity risk, while the loans the company makes earn returns calibrated to credit risk. Using equity to fund the loan book permanently leaves the equity investor bearing credit risk at equity return expectations, which tends to produce a capital structure significantly more expensive than necessary for the portfolio funding purpose. Venture debt, warehouse facilities and asset-backed securities — the latter still rare but beginning to emerge in more mature African fintech ecosystems — allow fintech lenders to use equity for the technology, risk management and operating infrastructure that genuinely requires risk capital while funding the loan portfolio with appropriately priced debt.

Beyond fintech, venture debt has found growing application among African startups in sectors including clean energy, logistics, agriculture technology and health technology — areas where companies often have tangible assets or contracted revenue streams that can provide meaningful security to debt investors even when the company overall remains pre-profitability. Solar energy companies building portfolios of pay-as-you-go consumer solar financing, for instance, have receivables — the future payments owed by solar customers — that can serve as collateral for structured debt facilities, allowing them to recycle equity capital and grow their portfolios faster than would be possible if each unit of portfolio growth required fresh equity.

The equity fundraising compression that has driven much of the current interest in venture debt has roots in both the global interest rate cycle and Africa-specific dynamics. The sharp rise in interest rates in the United States and Europe in 2022 and 2023 reduced the risk appetite of global venture capital investors and increased the appeal of fixed-income alternatives relative to high-risk venture exposure, prompting many global funds to reduce their commitments to emerging market venture capital including Africa. At the same time, several high-profile African startup failures and valuation write-downs among previously celebrated companies increased selectivity and due diligence rigor among the investors that remained active, raising the bar for new equity fundraising in ways that made it more time-consuming, uncertain and dilutive than founders had grown accustomed to during the preceding boom period.

The risk profile of venture debt is not uniform, and African startups and their investors have learned through experience some of the conditions under which the instrument adds genuine value versus those where it can create financial distress. Venture debt taken on by companies with uncertain or declining revenue projections — used to extend runway when equity is not available rather than to fund profitable growth — can convert a capital-raising challenge into a covenant breach or default if the company fails to achieve the milestones on which the debt structure was premised. Several African startups have encountered exactly this situation during the funding contraction of recent years, when optimistic growth projections built into debt structures proved difficult to achieve in a more challenging operating environment, triggering restructuring conversations with lenders that founders had hoped to avoid.

The lender landscape for African venture debt has diversified considerably over the past five years. Dedicated venture debt funds with Africa focus have been established by several impact-oriented and commercially oriented managers. Multilateral development finance arms — including the International Finance Corporation, the European Investment Bank’s development arm and several bilateral DFI operations — have extended venture debt as part of their broader private sector development mandates. A smaller but growing number of commercial banks in markets including Nigeria, Kenya, South Africa and Egypt have developed product offerings aimed at later-stage startups with sufficient track records to service structured debt, recognizing that the growing startup ecosystem represents a client segment worth building capability to serve.

Term structures for African venture debt have generally been shorter than those typical in more developed markets, reflecting lender caution about multi-year commitments in economies where macroeconomic conditions can shift significantly within a year or two. Three-year facilities are more common than five, with amortization schedules often front-loaded relative to what US or European venture debt equivalents might offer. Interest rates, while attractive compared with equity cost of capital for well-managed deployment, carry country risk premiums that reflect the higher operating risk of African markets relative to more stable jurisdictions.

Looking at the trajectory of the asset class, most practitioners expect venture debt availability for African startups to continue growing as the ecosystem matures. More startup track records mean more data for lenders to underwrite against; more successful loan repayments build the institutional confidence among lenders that the risk is manageable; and more sophisticated founders and CFOs mean better-structured facilities that work for both sides of the transaction. The instrument will not replace equity for the early-stage, high-uncertainty investments that genuinely require risk capital and patient ownership rather than fixed-return debt, but it is becoming an increasingly important tool in the capital stack of Africa’s more mature growth-stage companies, filling a financing gap that has historically forced many to choose between expensive equity dilution and growth constraints that limited their competitive position.

The development finance institution role in catalyzing the African venture debt market merits particular attention. DFIs have served not only as direct lenders but as risk-sharing partners for commercial lenders that might otherwise find the risk-return profile of African startup debt too unfamiliar to underwrite confidently on their own balance sheets. First-loss guarantee structures, in which a DFI absorbs the first tranche of losses on a portfolio of startup loans originated by a commercial bank, have allowed commercial institutions to participate in the market with a degree of risk protection that makes the underwriting economics work, while building the institutional knowledge and track record that may allow them to operate without first-loss support in future vintages. This layered-risk approach, familiar from agricultural and SME lending programs, has proven transferable to the startup debt context and has materially expanded the pool of capital available to African growth companies at a time when pure equity was constrained.

The warrant coverage typically attached to venture debt — the right for lenders to purchase equity at a predetermined price, providing upside participation beyond the interest coupon — has introduced an additional dimension of sophistication to discussions between startups and debt investors. Founders who have become more equity-aware following years of watching dilution accumulate through successive rounds have generally sought to minimize warrant coverage, while lenders have sought coverage sufficient to compensate for the binary risk of startup lending in a meaningful way. Negotiating an acceptable structure requires both parties to have views on likely future equity valuations, a discussion that has the useful side effect of forcing founders and finance teams to articulate and defend their growth projections with more discipline than is always required in pure equity fundraising conversations where investor appetite may be more sentiment-driven than analysis-driven.