Nigerian startups are turning to debt but not everyone is ready -

Debt is rising as a growth tool for Nigerian startups, but only the mature can handle it.

In recent years, more African startups have turned to debt financing, even as venture capital investments decline. Debt accounted for just 6% of total startup funding in 2021, but that figure rose to 25% in 2023 before settling at 18% in 2024. For many startups, debt offers a faster route to capital, helping them meet immediate business objectives. More significantly, it allows them to avoid raising equity at unfavourable valuations or taking on excessive dilution, ultimately positioning both founders and investors for stronger exits when opportunities arise.

Yet despite its growing appeal, debt financing isn’t suitable for every startup. In this conversation with Techpoint Africa, Patrick Igwe, Fintech Business Officer at FSDH Merchant Bank, discusses what makes a startup a good candidate for debt financing and highlights key risks lenders watch for.

What is the state of debt funding for Nigerian startups today?

Going by the way the ecosystem is growing, more tech companies are beginning to see the importance of debt funding for their business. It is much quicker, and it gives them the opportunity to scale beyond what is currently out there, especially if they’re able to access debt funding at a very affordable rate.

Beyond having predictable cash flows, are there any other characteristics of businesses that are suitable for debt funding?

Your business must have matured to a certain level before you can begin to seek debt capital. I see very early-stage companies looking for debt capital, and that’s a no-no. In fact, it can destabilise your business because you do not want to start paying up debts when your business is just starting.

At that point, it is usually best for you to secure equity, but when you decide to scale, when you have observed that your business has gotten to that point where it can expand into other regions, that’s when you begin to seek debt capital.

There are different types of debt financing products. We have invoice financing, which is basically just a product that allows you to tender an invoice and have a financing house finance that particular deal on your behalf.

We also have contract financing. As the name implies, the contract has been signed, and the timelines for paying the contract are written into it. That gives the financing house some sort of confidence.

There are also other means of financing debt. There is debt financing proper, which we call term loans. That means that once a particular amount has been put aside for a particular company, principal and interest repayments have to be made monthly. It’s important to know that the interest rate in Nigeria is very high, which is why it’s best to seek affordable debt financing.

What kind of lenders are currently active in Nigeria?

We have a number of development finance institutions (DFIs). Those types of lenders actually partner with financing houses like us to provide intervention funds or at least concessionary funds. We also have those who provide debt capital off the bank’s balance sheet or off the financing institution’s balance sheet. That is a much more expensive type of finance to access.

You typically want to target financing institutions that can provide concessionary funds. However, it’s not only important to look for concessionary funds. Sometimes, a blend of the financial institution’s own fund and the concessional fund shows the strength and capacity of your business.

To access debt financing, we want to see your financials. You typically need at least three years of audited financials, your updated management account, and your one-year bank statement across all banks or all financing houses. Depending on the type of debt financing you want to access, if it’s invoice financing, the financing house will ask for the invoice or the contract.

What are some mistakes that founders make when seeking debt funding?

One of the key mistakes founders make when coming for debt is that their books are not in order. Some of them do not even have financials.

The financials help us understand the trend of your business over the course of three years, whether the business has been making strides towards profitability, whether there have been losses, and what factors led to the losses.

Banks, in general, are in the business of making profit, and they do not want to give their money to someone they are not assured will be able to return those funds. Another mistake founders make is that sometimes, they give their financials to very unreliable auditors who position their business in a worse light.

How do you assess creditworthiness for startups?

I first check their track record. I begin to check what the business has been doing over the years, down to their credit history. This is not novel, but we get their registration certificate (RC) numbers and put them through the credit bureau just to see if there are any outstanding debts.

That’s the first point of call. Personally, I would ensure that the business is credible before even taking them through the length of the process, and then we begin to analyse their financial position to understand how much they are eligible for.

Once that has been done, we bring these findings to the risk team. The risk team is in charge of determining the risk within that business. As I mentioned, I want to be sure that this business is viable and that I understand the company’s business model before I say it is eligible for debt capital.

Then I want to analyse the market of that business. Does that industry have the potential to grow, or is it stagnant at the moment? So in a nutshell, those are the things that I would look out for.

Most of the time, founders tend to shy away from the conversation around collateral, but the honest truth is because of the landscape in Africa, most financial institutions will lend off collateral.

Knowing that startups are asset-light, we won’t ask for assets like your property. But if you know you will take on debt capital, it’s usually a good idea to have assets that you can rely on. Assets like Eurobonds or treasury bills are good assets to have.

What hidden risks or costs do startups overlook when signing loan agreements?

Once everything has been analysed and you are eligible, an offer letter will be given. It is very critical that you read through the terms of the offer so that you do not have a financier coming back to you with those hidden things that you might have overlooked because you were too excited about the offer.

Speaking of hidden risks, you would typically see things like turnover covenants. That normally means we are giving you this, and you are supposed to do a minimum amount on that account. Failure to do that may result in some consequences. One consequence could be a recall of the credit facility. It could also mean that the next time you ask for a credit facility, they might be unwilling to extend it.

So it’s always good to read every word, and if you do not understand it, get a legal person to help.

At what point should startups consider some of the financing types you have mentioned?

Your goals often determine the type of debt financing you pursue or even obtain. I previously referred to invoice financing.

Invoice financing is typically for trade businesses. Maybe they want to import or export some products. On the other hand, term loans or working capital loans are loans you get when you have something urgent to attend to and need the cash. You can’t take invoice financing when you need cash because we don’t give you the cash, but finance the deal on your behalf.

Can startups negotiate the terms of their financing agreements?

Yes and no. The monetary policy rate (MPR) right now is somewhere around 27%, and financing houses are not NGOs. There is a limit to your negotiating power. You can negotiate, but if it falls below the MPR rate or a certain rate, then they’re not going to do that. There are situations where the bank is able to lend below the MPR rate, and that speaks to the concessionary funds that banks get or the intervention funds that the banks will get.

How early should startups involve lawyers when seeking debt financing?

Because startups are often lean, not all startups can get legal advice, even though it’s advised.

If you can access debt, it means your business has scaled to a particular extent. I would not typically advise every startup founder to access debt. It’s for those startups that are scaling and have found product-market fit. If your product has found product-market fit, it means that you can afford certain things, and legal advice is one thing that I would advise you to get early.

We are in a regulatory-heavy environment, so it is advised that you have things like compliance, legal advice, and even auditors in place.

What should a startup do if it discovers it may be unable to repay a loan?

Remember I said earlier that an analysis would be done on the company? That analysis helps us understand whether this company is able to repay its loans. If the analysis is done properly, then this scenario will not come up.

Where this is not the case, most financing houses have policies on this point. Typically, there is a relationship manager in place for that particular company or startup. So, even before the facility gets bad, different engagements would have been made with that person to try and mitigate that.