Equity financing has long been the primary funding avenue for startups in Africa. In their early stages, startups typically relied on equity rounds—trading ownership stakes for investment. However, as the ecosystem has evolved and lender confidence has grown, debt financing has emerged as an increasingly viable option. Debt allows startups to access capital with an obligation to repay, often making it more attractive for those with strong growth potential and operational stability.Recent data reveals a significant rise in debt funding across Africa. In 2022, startups raised $1.55 billion in debt across 71 deals, effectively doubling the amount recorded in the previous year. This trend is largely driven by the maturation of many startups and the capital-intensive nature of sectors like fintech and cleantech. Fintech accounted for 45% of the total debt funding, while cleantech followed closely with 39%. Notable deals included Moove, a mobility-focused fintech, raising nearly $200 million, and MNT-Halan, an Egyptian microfinance platform, securing $150 million.According to financial experts, fintech’s demand for debt is tied to working capital needs that equity investments alone cannot meet. Meanwhile, cleantech ventures often require significant financing for infrastructure and equipment—areas where traditional venture capital may not suffice.
Rising Interest Rates and Their Effects
The global economic slowdown and inflationary pressures have led central banks worldwide to raise interest rates. By increasing borrowing costs, these measures aim to curb inflation by reducing spending and demand. For example, the U.S. Federal Reserve has raised rates nine times since March 2022, reaching 4.9%. Similarly, Nigeria and Ghana have raised their interest rates to 18% and 29.5%, respectively.For startups, these rate hikes signal higher borrowing costs, especially for those relying on dollar-denominated debt. This creates a challenging environment, particularly in markets already dealing with currency devaluations. The added pressure of managing currency risks and repayment costs may reduce investor appetite for venture debt, especially from international sources.
Vulnerable Sectors
Fintech subsectors like consumer lending, buy-now-pay-later services, and SME financing are particularly vulnerable in this environment. Delayed repayments and the strain on consumer finances could further tighten credit availability. Additionally, startups relying on floating interest rates—where borrowing costs adjust with market conditions—are likely to face increased challenges.
Mitigating Strategies for Startups
To navigate these headwinds, startups can adopt several strategies:
1. Ensure Viable Margins: Startups must focus on products with healthy margins that can absorb higher borrowing costs. Proper underwriting and collection practices are also critical to maintaining repayment rates.
2. Hedge Currency Risks: Utilizing tools like derivatives or back-to-back facilities can help startups manage the risk of currency devaluations, especially for dollar-denominated debt.
3. Local Currency Solutions: Raising debt in local currencies can mitigate exchange rate risks. However, the availability of well-structured local currency options remains limited.
4. Collaborative Financing Models: Startups can partner with financial institutions to underwrite consumer loans, reducing their direct exposure to credit risk.
For example, Vendease, a logistics and inventory platform, has adopted a partnership model where local finance companies provide credit to its users. This approach enables startups to focus on core operations while earning commissions from underwriting data.
Conclusion
While debt financing remains an essential funding tool for startups, the current high-interest environment necessitates careful planning and strategic adjustments. By exploring local financing options, managing currency risks, and partnering with financial institutions, startups can weather the challenges posed by rising interest rates while positioning themselves for sustainable growth.
