Debt is no longer a dirty word in European tech.
European startups have raised €8.3bn of it so far in 2021 — topping the previous record of 2017. That also compares to just €1.6bn raised in 2015, a growth rate almost double that of the US.
Debt financing is a type of loan that comes from a specialist lender or a debt fund, and it’s quickly shaking off its reputation as a second-class alternative to venture capital for startups. Unlike the equity stakes that venture capitalists take in startups, debt does not give lenders ownership in the business though it does come with interest costs.
“I think a lot of companies, especially if they have recurring revenue and predictable business models, have started to realise that VC funding isn’t necessarily a good deal and there are many more options available. As a result, debt financing is gaining in popularity," Capchase’s European GM Henrik Grim tells Sifted.
Why is debt funding on the rise?
Investors and lenders say a maturing VC market and the prominence of repeat founders in Europe are two key drivers of the shift.
“I think the market has really moved on...dramatically in the last two or three years,” says Sonya Iovieno, head of venture and growth at tech startup lender Silicon Valley Bank. “We’ve seen a plethora of new debt funds get funded…and we’ve got a big pool of talent who really understand this market.”
“One of the reasons [for the rise of debt financing] is the growth of the market we’ve seen... you’ve got [entrepreneur] role models now in Europe,” Ross Ahlgren, general partner at debt fund Kreos, tells Sifted. “The US was a hotbed for that early on and it just took a bit longer to reach Europe.”
As momentum built in the US, more entrepreneurs would see other companies use debt, says Ahlgren, leading to a domino effect. A similar pattern is now emerging in Europe.
“We did an ecosystem survey last year and found that if you have experienced working with venture debt you're highly likely to use it again...If you haven't ever accessed it before I think there's still that kind of knowledge barrier there,” Iovieno tells Sifted
The growing experience of Europe’s current crop of founders is beginning to erode that knowledge barrier.
“Maybe five years ago we'd say, ‘well we're just about seeing the odd repeat founder’, but now we are genuinely seeing founders that are doing it for the third or fourth time,” says Iovieno.
“The US tech industry is slightly ahead of Europe in terms of embracing debt as a funding route, however, the gap is narrowing," says Capchase's Grim, adding that the company has seen a "huge surge" in interest from European entrepreneurs in the last six months and made $100 million available to more than 50 companies in the company's first month of operations in Europe.
Bolstering the coffers between rounds
Simply put, taking on debt financing means a company gets cash without giving away control over the business — which is an attractive proposition for shareholders.
But the type of debt financing a company takes on depends heavily on the stage a company is at and what the company does.
Zephr, a SaaS startup that works with publishers, took on venture debt at its Series A round towards the end of 2020. Finance director Jamie Walker, says the decision was meant to extend the time before needing to raise again.
“The longer we can have between funding rounds, the better the valuation we should get for our next funding round,” he tells Sifted. For a rapidly-growing startup — especially a SaaS — operating in the current climate of overnight mega-valuations, keeping hold of shares can have huge benefits.
Zephr was unable to share exactly how much of the $8m round was venture debt, but Walker did say that the startup was “not atypical” of the industry standard of around 20-30%. The venture debt was raised as part of the round, with VCs BDMI, Nauta Capital and Knight Capital providing the cash-for-equity, and SVB the debt.
Technology subscription platform Grover recently raised a whopping €850m of debt in asset-backed funding. Unlike Zephr’s venture debt, this was separate from its standard venture capital rounds. The capital also can’t be used for propping up the startup’s general growth — like marketing or hiring — only for purchasing the tech it rents out.
Chief financial officer Thomas Antonioli tells Sifted that for business models requiring bulk purchasing of physical assets, debt funding is an increasingly attractive prospect and a safe one for the investors.
“For a while, there was a stigma attached to capital intensive business models [like Grover] from equity providers and venture capitalists, but that’s now changing,” he says. Antonioli points to the emergence of a number of subscription based business models — like cars, consumer electronics and fashion — that have begun to use debt funding to scale.
The safety net for the investors lies in the fact that the loan is guaranteed against the physical assets, which will always be resellable, even if the company goes bust.
In the past, Antonioli tells Sifted, “people wouldn't even start these businesses before because they knew that there would not be capital available”, but debt funding has created a more “virtuous cycle”.
Grover has raised nearly €1.1bn in debt funding across eight rounds since 2017, alongside €117m in venture capital.
What’s next for debt financing?
While debt financing is on an upward trajectory in Europe, it’s not yet reached its zenith.
To really take advantage of the upcurve in debt funding, SVB’s Iovieno says, the ecosystem needs more providers and more capital.
A lack of providers in Europe versus the US means interest rates for founders are less competitive, says Zephr’s Walker. But the more competition there is, the more rates will go down — and that will further encourage founders along the debt funding route.