Venture Debt amidst COVID-19: Majority of GCC startups willing to take on short-term debt to combat crisis effects

The COVID-19 pandemic has transformed from a health crisis to a global economic recession. The repercussions for entrepreneurs and tech engineers are especially severe due to limited access to liquidity. Governments around the world and in the region have introduced significant stimulus packages to soften the blow on the economies. 

Still, those resources are difficult to access for SMEs and especially so for asset-light technology startups. At the same time, it is essential to note that technology proved a key enabler during working from home, social distancing, and quarantine.

In early April, we – Roland Berger, Al Tamimi, Grant Thornton, and Badr Ward – initiated a discussion between investors, fund managers, and entrepreneurs, aimed to find a collaborative solution to protect both startups and venture portfolios. From those conversations, it became evident that the rapid deployment of a dedicated support mechanism for startups and SMEs across the region is necessary to make sure that our tech champions survive.

One of our concerns has been that the temporary liquidity crunch will force startups to decrease headcount. This was validated by the recently announced layoffs by Careem and Kitopi, also confirming that speed is critical for this relief effort to be effective in preventing a long term negative impact on the ecosystem (like talent drain for example).

To ensure rapid and selective liquidity deployment, we are designing a streamlined assessment process and standardized documentation based on a venture debt structure.

What is Venture Debt? 

Venture debt is a debt instrument suitable for venture-backed start-ups that do not have considerable assets or a positive cash flow to use as collateral. 

Convertible notes are one form of venture debt that became widely popular thanks to standardized structures such as SAFE note (introduced by Y Combinator) and KISS note (introduced by 500 Startups). It is also relatively common in the MENA region.

Venture term loans are another form of venture debt, which has some notable advantages from the startup's perspective:

•  Minimize dilution (compared to equity rounds)
•  Extend cash runway to weather a downturn and avoid raising a down-round
•  Lighter board / control requirements compared to equity

The obvious consideration for startups is that venture loans must be paid back out of the cash-flow of the company (or refinanced by a following funding round), which is typically not the case with equity investments.

In addition to having a loan repayment plan, a key selection criterion for venture loan investors is for startups to have already raised external capital. This is in place to provide security to the debt investors that a qualified investor (the VC backer) has conducted robust due diligence and has validated the viability of the startup.

Typical parameters of venture term loans:

•  Size: USD 100,000+ (maximum amount usually is a percentage of the valuation at the latest round or the annual revenues of the startup)
•  Interest rate: 8 to 15%
•  Tenure: 1 to 3 years
•  Include warrants

Warrants are right to purchase equity that give the debt provider an option for upside exposure and are an integral part of venture term loans. Warrants typically amount to 10-20% of the loan size.

Find out more in this 101-guide to venture debts

In this context, we designed a short survey that, with the help of regional investors reached a substantial part of the local entrepreneurial community. Over three weeks in April/May, we received more than 350 responses, predominantly from the GCC.

Geographical split

Impact across profitability stages 

In line with what we have seen around the globe, about 60% of regional startups across all profitability stages have experienced a severe negative impact from the COVID-19 outbreak.

Venture-backed and/or have debt

To facilitate rapid capital deployment, the process relies on a VC firm having previously conducted thorough due diligence. In addition, the involvement of a professional external investor means that most likely key performance metrics of the company are being tracked and validated regularly. In that context, startups that have previously received venture and/or debt funding are more suitable applicants for the venture debt instrument. Over 55% of the respondents fall in either or both of those categories.

Interested in debt

As we suspected, over 90% of the startups are interested in debt funding as emergency liquidity to weather through the COVID downturn, with two-thirds of those interested looking for under USD 500,000.

Considering the relatively small transaction size, it is critical that the process is as streamlined as possible to reduce administrative burden on both investors and startups.

The insights from the survey have helped us better define the needs of the local startup ecosystem as we continue to look for a path forward. We continue to work around the clock with investors and entrepreneurs to finalize a structured solution and bring much needed liquidity relief to the ecosystem as soon as possible.

With Mawdoo3, Jamalon, and HyperPay raising a combined $33M in total funding in 2019, it was a record year by funding for the Jordanian startup ecosystem. Learn more about one of MENA's oldest ecosystems in our 2019 Jordan Venture Investment Report.