European start-ups turn to complex debt deals as cash dries up
LONDON — European venture capital-backed companies are signing up to increasingly complex convertible debt deals which risk giving investors more control or bigger payouts further down the road, people involved in the deals told Reuters.
Ultra-low interest rates allowed growing companies to complete equity funding rounds at sky-high valuations during a boom in 2020 and 2021. But as venture funding has dried up, companies and their investors have been wary of equity funding rounds which risk establishing a new, lower valuation.
Convertible debt, which changes into equity after a set period, can enable company founders to raise cash quickly and privately, without publishing an updated valuation.
The volume of convertible debt issued by European venture capital-backed firms hit a record $2.5 billion in 2023, up from $1.7 billion in 2022, Dealroom data compiled for Reuters shows.
But as the deals become more complex, they can offer investors more upside and create risks for the companies, according to Reuters interviews with lawyers, company founders, and an investor familiar with the deals.
“Deals can be structured to create an incentive for the company to IPO or raise more funds, for example by having interest rates which accrue over time,” said James Wootton, a partner at law firm Linklaters.
“For some, convertibles offer an opportunity to secure alternative longer-term funding while waiting for venture capital market conditions to improve,” said Josef Fuss, a London-based partner at law firm Taylor Wessing.
Venture fundraising in Europe has slowed sharply, from $130 billion in 2021 to $62 billion in 2023, leaving some early-stage firms in a funding crunch as they burn through cash.
“It’s the hardest market I’ve worked in my professional career,” said James Downing, managing director for Europe at Hercules, a venture lender.
While not all firms using debt are running out of cash or avoiding a revaluation, and convertibles are not necessarily risky, experts warn that delaying revaluations may not be a good long-term strategy.
“Delaying revaluations is not a good strategy because at the end of the day it’s the truth, it comes out, you can’t escape,” said Gerhard Kling, Chair of Finance at Aberdeen University. “It’s a bit of a gamble, you hope the market condition improves but I’m not entirely convinced it will.”
