(Ecofin Agency) - Africa is shifting away from a venture capital-only model, embracing a more diversified approach that may seem pragmatic. Debt is gaining traction, but can the market handle this shift without sacrificing disruptive innovation to financial caution and cost pressures?

A few years ago, venture capital was the go-to option for funding African startups. But things have changed. Debt is now becoming a solid alternative to equity fundraising, which has been plummeting for the past three years.

According to the "Africa Investment 2024" report by British firm Briter Bridges, the share of debt in financial transactions on the continent jumped from 5% to nearly 20% between 2021 and 2022. Since then, it has leveled off at around $500 million per year in disclosed deals, despite economic challenges. At the same time, equity financing has dropped by more than 60% since its 2021 peak, now standing at just under $2 billion. As a result, debt is gaining ground and starting to play a bigger role in Africa’s venture capital ecosystem.

From Venture Capital Boom to Investor Caution

The illusion of endless venture capital is fading as the global market tightens. After a decade of growth where African startups raised hundreds of millions, investors are now scrutinizing financial reports more closely. Rising interest rates—jumping from 0.25% to over 5.25% in the U.S. in just two years—and declining valuations—some fintechs have seen theirs plunge by as much as 500%—are driving this shift. Tougher exit conditions for private equity funds are also playing a part.

The result is less equity and more debt. Startups are being forced to rethink their strategies, moving away from dilutive funding rounds and opting for loans instead. This trend is especially beneficial for more mature companies that can prove their profitability and reassure lenders.

Institutional Players Step In

The rise of debt financing in Africa is also fueled by international development agencies. Organizations like the U.S. International Development Finance Corporation, British International Investment, France’s Proparco, and the International Finance Corporation have ramped up their involvement, injecting funds through loans and guarantees. This is a pragmatic choice: while venture capital struggles to find new growth avenues, debt allows for quicker resource recycling and better risk management.

But it is not just public institutions getting involved. Private funds like BlueOrchard, responsAbility, and Lendable are seizing this opportunity to offer small and medium-sized enterprises (SMEs) and startups financing options better suited to their needs. Instead of dilutive equity, structured loans and mezzanine financing are becoming more common, often with larger amounts than traditional fundraising rounds.

A New Financing Model?

Debt is gaining traction partly because it matches the structural changes in the market. Gone are the days of eye-popping funding rounds. Now, the focus is back on fundamentals, with immediate profitability taking precedence over risky ventures. Fintech, renewable energy, and digital infrastructure are some of the sectors benefiting the most from this shift. These industries are particularly suited to debt financing because their assets can be used as collateral.

However, one key question remains: Can debt truly replace equity? The answer is far from clear. Access to loans is still unequal, favoring more established companies. For younger startups, equity often remains the only viable path to capital—if they are willing to pay the price.

Challenges of Rising Debt

This shift toward debt financing doesn't come without its challenges. Unlike venture capital, which involves equity stakes and longer-term horizons for profitability, debt comes with strict deadlines and immediate repayment expectations. This puts added pressure on companies. High-interest rates, often between 9% and 14%, make capital more expensive and expose borrowers to currency fluctuations—a significant risk in African economies where local currencies can lose up to 30% of their value against the dollar in just one year. In such an environment, repaying loans in foreign currencies can quickly become a trap.

Moreover, access to credit remains limited to businesses with stable cash flows and sufficient collateral, making it inaccessible for many early-stage startups.

This transition to a debt-driven model could stifle innovation, favoring safer sectors at the expense of emerging industries and disruptive technologies, which need patient investment and a higher tolerance for risk.