Venture debt funding in MENA
By Gabriel Estevez, Partner
With venture funding in MENA still subdued due to the current macroeconomic environment, start-ups are considering other options to secure capital. One form of financing that we've seen grow in popularity over the past few years is venture debt, with data from MAGNiTT showing debt investment in MENA growing from $250m in H1 2022 to $644m in H1 2023.
To help give you an overview of venture debt we sat down with Gabriel Estevez, one of our UK partners, to discuss how he's seen the market evolve, what venture debt involves and the advantages it offers over equity.
Q: What is venture debt and how has it evolved as a financing option for start-ups?
A: Venture debt is a form of financing tailored for scaling start-ups, particularly those in the tech sector. It gained popularity in the early 2000s, offering an alternative to traditional lenders for pre-profit tech companies without tangible assets.
Q: How has the venture debt market changed over the past few years, and who are some of the prominent players in this space?
A: The venture debt market has seen remarkable growth over the last 15 years, with established lenders like SVB UK (now part of HSBC as HSBC Innovation Bank), TriplePoint, and Kreos joined by a diverse set of new players.
Q: What are the primary reasons companies opt for venture debt, and can you elaborate on how it supports their growth?
A: Companies turn to venture debt for various purposes, including fuelling growth through research, product development, and marketing efforts. It can also extend their cash runway, aid in acquisitions, streamline shareholder bases, or be used to navigate unforeseen setbacks.
Q: What kinds of companies are suited to venture debt?
A: Venture debt is traditionally available to start-ups who have already obtained some form of capital investment. Lenders prefer to provide debt to start-ups who can demonstrate other reputable investors have already backed them (ie growth stage rather than seed stage companies).
The debt provided also tends to be linked to performance metrics like start-up financials, cash burn projection and the growth projection of the company and the quantum of debt and structuring of repayment will be tailored around these types of metrics.
Q: How does venture debt differ from equity investments, and what advantages does it offer to start-ups?
A: Venture debt provides a quicker alternative to equity investments while allowing start-ups to retain equity. This means more potential returns on exit, and it can help meet targets for future funding rounds without immediate dilution or loss of control.
Q: Can you shed light on the typical terms, structures, and security arrangements associated with venture debt?
A: Venture debt terms can vary, but they usually involve a repayment period of two to five years with an agreed-upon interest rate. Loans may be contingent on achieving specific growth metrics, and security packages often include fixed and floating charge security, share security, guarantees, and subordination agreements.
Q: Are there restrictions on shareholder distributions when venture debt is in place, and what considerations should start-ups keep in mind?
A: Typically, venture debt lenders may require consent for shareholder distributions until the loan is fully repaid. Start-ups should also ensure that all debt obligations within their structure are subordinated to the senior-ranking debt of the venture debt lender.
Q: What challenges do venture debt lenders and borrowers face in the MENA market?
A: The main challenges we're seeing acting for companies and funds in the region include:
- Company structures – we often see multiple jurisdictional structures on MENA deals, which can include onshore and offshore components. Having multiple legal jurisdictions and multiple laws governing different companies in the structure can create additional legal complexities compared to typical single jurisdiction structures seen in the venture debt markets in the US and UK.
- Enforcement options – the perfection, registration and enforcement of security is often simpler in common law jurisdictions in comparison to civil law jurisdictions. Onshore and offshore security requirements and enforcement can vary substantially in the MENA region compared with English law or New York law, for example.
- Cost and counsel – the structure and enforcement points noted above can often lead to additional negotiation, increased costs and multiple legal counsels required across different jurisdictions to navigate these challenges. Local cultural legal requirements related to Sharia law financing may also need to be considered when seeking venture debt in certain jurisdictions in the MENA market.
