Have you ever considered raising capital outside grants and equity financing? Are you a startup founder looking to raise funds without the need to give out shares in your company? Well, you should consider raising capital through the venture debt mechanism.
Venture debt is a term used to describe a transaction in which a startup borrows money with the promise to pay back with interest on an agreed date. Despite the equity retention benefits venture debts give startup founders, it is yet to be popularized in the African venture capital ecosystem. But why is this the case?
In this article, we will talk about the key benefits of venture debts.
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Top 5 Reasons Why You Adopt Debt Financing
- Helps minimize dilution: Venture debts affords founders the opportunity to get more cash injected into their businesses without the need to give out much equity to investors. Hence, you can have raised through equity and debt financing at the same time, thereby giving out equity and preserving the rest. A good example of this is how Tradedepot raised $110 million with 38% being equity financing and 62% being debt financing.
- Avoid Bad Equity Investor Behaviour: There are many stories of investors meddling in the affairs of a startup, calling startup founders to meetings regularly amongst other toxic behaviors, thus not giving founders the chance to implement the ideas they have for their startups. With debt financing, you can oversee day-to-day management of the business with funds obtained with an agreement to pay at a later time.
- Extension of cash runway: Equity financing rounds are often associated with setting milestones a startup must meet before another round of financing can be commenced. More often than not, startups find it difficult to meet up with these milestones due to various factors. This does not apply in debt financing as Venture debts give startups more time to achieve their target milestones due to the lengthy duration of the payback period.
- Expansion and capital projects: Venture debts are a good startup investment option for companies looking to expand and acquire expensive operating assets for their operations. For instance, Moove, a Nigerian-based mobility fintech startup raised $10m in venture debts in the first quarter of 2022. The company currently serves as Uber’s sole vehicle supply and financing partner in Africa and this explains one of the reasons why it would need a distinct capital raising process like venture debts to help the company “empower more mobility entrepreneurs in Africa.”
- Interest payments are tax deductible: In African countries such as Nigeria, tax considerations are given to debt financing to make it more attractive for foreign investors. Hence, the interest paid on venture debts are not subject to Withholding tax for both the investor and the company.
Conclusion
In summary, the idea of companies borrowing capital to finance their business activities is not a novel thing in the world of finance. M-Kopa, Babban Gona, Twiga Foods, Daystar Power, Pay later, Rensource Energy are common examples of venture debt backed companies in Africa.
