Venture debt is a hot topic in the MENA region. This new asset class generates rewarding returns – between 14 and 17 percent IRR on average – and is attracting traditional investors, investment bankers, VC funds and even banks.
Understanding venture debt in the MENA region
Provided to VC-backed technology startups, venture debt is ramping up, and is on track to constitute 10 percent of total venture capital in the MENA region very soon.
According to MAGNITT’s recent MENA Venture Debt Report, the contribution of international (non-MENA) investors in 2022 increased from 20% in 2021 to c.50% in 2022, indicating that the proportion of international investors is increasing.
Notably, the hesitancy of MENA investors in venture debt is not due to a lack of capital. On the contrary, the MENA region – and particularly the Gulf region – has a lot of dry powder. So, let’s take a closer look at the factors that might be preventing financiers from investing in venture debt.
- Lack of data: Traditional financial institutions in particular have found that there is a lack of start-up available and reliable data for them to make informed investment decisions.
- Understanding business model: It’s no secret that banks and traditional investors fail to understand start-ups. During the screening process, they look for profitability and assets while the focus should be on a start-up’s growth potential, unit economics, and ability to scale. Understanding the business models of tech start-ups and the unique metrics associated with these types of models will inform decisions regarding venture debt.
- Payment collection: The collection of securities from startups allows investors to enforce punitive measures in the event of default. However, since investors have no control over start-ups’ bank accounts and cashflows, collection is by no means a guarantee. Since the collection of securities creates high friction, this can also slow scaling.
- Precise performance monitoring: Start-ups operate at a very fast pace, and financiers need to keep an eye on their performance to intervene at the right moment. However, it can be challenging for investors to obtain monthly or quarterly reports (since search costs and friction are high) from start-ups.
- Culture: Debt is associated with interest which is not in line with Islamic shariah standards.
- Fragmentation: The MENA region is a fragmented market when it comes to lending, since each country has its own central bank and corresponding regulations. This means that there is a significant burden on both start-ups and investors when it comes to expansion in order to comply with all relevant regulations.
- Misconceived notions regarding risks: Venture debt is often perceived as being a high-risk investment, which is one of the key reasons why uptake in the MENA region has been slow especially by traditional financiers. However, default rates in the U.S. for venture debt are only two percent, as compared to nearly 18 percent for small business loans.
Venture debt outlook in MENA
For high-growth technology companies who traditionally only raised equity, venture debt is fast-emerging as an alternative and complementary source of financing. For MENA investors, the continuous evolution in technology has the potential to decrease the risks associated with venture debt, creating an enabling environment for tech start-ups and investors alike in many ways.
- The use of APIs allows capital providers to assess traction and financial feasibility, based on real live data which improves visibility, especially on the revenue-based lending side.
- The growth of open banking has made start-ups’ bank data and information more easily accessible to potential and future financiers. New opportunities for venture debt will be unlocked with open banking since more data will become available, and financial institutions will gain confidence in the ability of these start-ups to automate regular payments reliably and consistently. Currently, there are several fintech start-ups in the MENA region such as Dapi and Lean Technologies who are building open banking infrastructure which will enable access to customer financial data and bank payments.
- The emergence of the CaaS model facilitates the efficient delivery of growth capital to start-ups on-demand. Using the help of consumption-based algorithms facilitated by technology, investors can quickly assess the viability, performance, and credit risk of a start-up based on live data. CaaS provides investors with a real-time, accurate exploration of both long and short-term investing, saving both time and money.
Our mission at Capifly is to accelerate and enable the deployment of venture debt at scale in the MENA region. We provide nondilutive capital to growing SaaS start-ups, and we also offer our technology infrastructure to existing capital providers allowing them to deploy venture debt in a structured and secured process. This infrastructure allows seamless integration with existing data sources such as accounting systems, payment gateways, and subscription management tools, and it analyses this data to price the risk and assess the ability of the start-up to pay back the facility. If you’re interested in learning more, please reach out.