Why debt financing is important for the African business

Small and medium-sized enterprises (SMEs) are the heart of Africa’s economies. According to the World Economic Forum, as engines of growth, SMEs are responsible for around 80 percent of the continent’s employment, ultimately helping to cut poverty and income inequality, enabling the establishment of a new middle class and driving demand for new goods and services.

That’s why creating an enabling environment for small firms to access finance will enhance their ability to not only contribute to Africa’s labour force, but also facilitate the continent’s development and economic growth while driving innovation needed to help solve the socio-economic issues it continues to grapple with.

However, despite Africa’s booming startup ecosystem, which (according to key findings from Startup Genome’s 2021 Global Startup Ecosystem Report for Africa) boasts a value of $6.6 billion, the continent’s SMEs still find it challenging to secure equity funding.

In addition to this, rising geopolitical tensions, global economic volatility and record inflation highs have created a more competitive fundraising environment, with investors becoming more risk-averse.

This could spell even greater trouble in access to financing as Africa has long been perceived as a high-risk environment for investors.

It is clear that SMEs have a significant role to play in helping to realise Africa’s economic potential. But, in order to turn this potential into reality, there needs to be a shift away from traditional equity funding towards a more debt-focused approach.

There is a lot of power in debt. Debt is how the world creates wealth and, at moderate levels, it can improve welfare and enhance growth. As such, debt financing offers SMEs the ability to receive funding without having to dilute equity.

Essentially, the lender gains no control over the business and once the debt is repaid the relationship with the lender ends, unlike traditional equity funding where the business sells a portion of its equity in return for capital.

Additionally, it is a lot easier for SMEs to forecast their expenses as a loan payment is consistent while interest on said debt financing can often be tax-deductible.

In this challenging financing landscape, venture debt (a type of loan aimed at early-stage, high-growth companies with venture capital backing) could prove to be particularly important for Africa’s SME ecosystem and the continent’s growth as a whole.

Unlike with other types of lending, SMEs will not need to showcase any positive earnings or cash flow in order to receive venture debt funding. As such, access to finance is exponentially improved in comparison to traditional equity.

Able to be used as performance insurance, funding for acquisitions or capital expenses, or to bridge the gap between venture capital rounds and carrying strong and stable interest rates, venture debt is extremely attractive for both SMEs, fund investors and development finance institutions alike.

Improving access to funding will help to equip SMEs with the tools and resources needed to innovate, create and discover in ways that entire communities stand to benefit.