Other types of Startup financing

Breaking down funding terms: what do equity, debt and hybrid financing mean?

By Timi Odueso

25th February 2022

Startup funding across Africa has grown by at least 600% since 2017. In 2021, African startups raised more than $4 billion, tripling the $1.43 billion raised in 2020. This total funding was made across 600+ funding deals. This means that funding announcements like the excerpt above—in differing variations—were published on media platforms over 600 times. It also means that you’ve seen those words over and over again, and you’ll definitely be seeing more in 2022, where startups have already raised over $1 billion across 130 funding deals. 

But what do these terms mean? What’s the difference between a Series A round and a Series D round? Who is an angel investor and what do they do? How does debt financing differ from equity financing?

In this guide, we’ll break down these funding terms across three categories: the fund types, the funders, and the funding stages.

The funding types

There are 2 major ways startups can get investors to fund them. There’s equity financing and debt financing. 

Equity Financing

In equity financing, the startup offers investors a chunk of ownership in the startup in exchange for funds. The investor is paying to own a part of the startup, which means that he also owns a share of the profits when the time comes. 

Think of it equity financing this way: The startup is a piece of farmland and needs money to buy seeds and farming equipment. In exchange for money, it offers an investor a small portion of the land and during the harvest, the investor gets whatever was planted on his portion of the land. 

Startups can sell as much of their equity as they want to. 

In equity financing, there’s no obligation for the startup to pay investors back because it’s technically a trade, and the investors are buying ownership. Thus, if the startup fails or makes no profit, the investors get nothing.

Startups can also buy back the ownership shares from the investor and this is called repurchasing or the repurchase option. Investors can also resell their shares to other investors which is one of the ways investors can exit a startup. 

Startups can also sell the rest of their equity shares to investors and this is called an exit. In an exit, the startup’s founders are basically selling their shares or ownership stakes in the company to other investors or companies who then acquire the startup. 

Debt financing

In debt financing, there’s no exchange of money for shares or equity. 

Instead, the startup collects loans i.e. gets investors to invest in exchange for a return on the capital, and a pre-agreed interest rate. 

Continuing with our farmland analogy, rather than paying for a portion of the farm, investors give the farm holders money on the condition that the farm holders pay back what they owe and an agreed-upon interest. 

The investors’ profit is not tied to how many shares they have, but how much they agreed on with the startups. In debt financing, there is an obligation for startups to repay; if a startup is unable to pay, whatever collateral they put down will be claimed by the investors. 

Other types of financing

There are a few other types of financing investors and startups may consider. 

First, there’s Hybrid financing which is where both debt and equity financing are combined. Last year, MFS Africa raised $100 million with $70 million as equity financing and $30 million as debt financing. 

There’s Mezzanine financing—or convertible debt or note—which allows investors to convert their debt financing into equity financing in the event a startup defaults on its debts. 

Finally, there’s Bootstrapping which means the startup finances itself through capital laid down by the founders, donations from family and friends, and/or rolled over profits. Many startups start out with bootstrapping.

Source: TechCabal