Funding African Startups 101: Navigating Equity, Debt and SAFE Instruments

Investing in startups requires not only capital but also a clear understanding of the instruments available. Whether through equity, convertible notes, SAFEs or even debt, each approach offers unique opportunities and challenges.

This article aims to help angel investors navigate the pros and cons of each instrument and serve as a practical guide by outlining their features, risks, and potential returns while considering the unique challenges and opportunities in our African markets.

Equity

Equity investments offer immediate ownership in a startup, aligning investor success directly with the company’s growth. Straight equity investments carry significant risk, as startups often fail. However, the upside potential is substantial if the company succeeds. Its key features include:

1. Ownership Stake:

• Investors get shares representing an immediate and defined percentage of ownership in the company proportional to their investment relative to the company’s post-money valuation.

Example: When Andela raised its early rounds, equity investors participated in its rise to becoming one of Africa’s unicorns.

2. Valuation Agreement:

• Investors must assess growth potential, often leveraging comparables in emerging markets like Africa in setting a valuation which can be challenging due to limited financial history but is critical to determining ownership percentage.
• This is because the investment requires agreement on the startup’s valuation to determine the price per share and the ownership percentage the investor will receive.

3. Shares and Rights:

• The specific type of shares received defines the investor’s rights and privileges:
  • Common Shares: Usually held by founders and employees.
  • Preferred Shares: Commonly offered to investors with additional rights and protections such as:
    • Liquidation Preferences: Priority in payout during an exit or liquidation. Example: A 1x liquidation preference ensures the investor receives at least their original investment before other payouts.
    • Anti-Dilution Protections: Straight equity is subject to dilution as the company raises more funds, issuing additional shares that reduce the percentage ownership of existing shareholders. This right safeguards against future down-rounds. 
• Example: Some investors in Flutterwave’s Series C funding round in 2021, when it raised $170 million benefited from these protections during its scaling phase round in February 2022, when it raised $250 million in a Series D funding round valued at $3 billion .

4. Control and Influence

• Equity investments can come with voting rights and investors may negotiate for board seats or observer rights, depending on the investment size, to monitor, influence and guide the venture’s strategic direction.

5. Exits

• The primary return comes from the appreciation in the company’s value. If the company grows, the value of the equity increases, allowing investors to profit at an exit event. 
• Receiving these returns depend on exits and the startups exit strategy is to ensure that  Investors benefit from an exit event, such as an:
  • Acquisition: When the startup company is bought by another entity.
    • Example: Paystack’s acquisition by Stripe in 2020 for $200 million provided a lucrative exit for its early investors.
  • IPO: The company goes public, offering shares on a stock exchange.
    • Example: A public offering offers large-scale liquidity and visibility like Jumia, a leading African e-commerce platform IPO on the NYSE in 2019.
  • Secondary Sale: Selling shares to another investor
    • NB: This is becoming an increasingly popular form of exit for early stage investors.

Example: In August 2024, Jumia raised $99.6 million through a secondary share offering. This move was aimed at fortifying its cash reserves and expanding its supply chain network. The secondary sale allowed existing shareholders to sell their shares to new investors, providing liquidity to early backers.

Equity investments provide investors with immediate ownership, voting rights, and potential upside from the company’s growth. However, it requires careful negotiation on valuation, share type, and investor protections, as well as a willingness to take on the inherent risks of early-stage investments. In some jurisdictions like Tunisia, Nigeria, Algeria and Senegal that have their National Startup Acts or similar legislation, equity investments qualify for tax benefits.

Convertible Notes

Convertible notes provide a flexible way to enter a deal early, deferring valuation debates until a later stage. It’s a form of short-term debt that converts into equity at a later stage, typically during the startup’s next funding round. Convertible notes are adaptable to the needs of the startup and investors, with customizable terms like caps, discounts, and maturity dates. It is a popular funding mechanism for early-stage startups. Its key features include:

1. Equity Conversion Discount

• A convertible note starts as a loan from the investor to the startup.
• Instead of repayment in cash, the loan converts into equity (shares) often at a negotiated discount (e.g., 20%) after a trigger event such as a qualifying funding round, offering an attractive entry price. Example: Example: If the discount rate is 20% and the valuation in the funding round is $1 million, the noteholder converts at an $800,000 valuation.
• Some convertible notes include rights for the investor to maintain their percentage ownership in the next funding round by contributing additional capital.

2. Valuation Cap

• No Immediate Valuation Needed! Unlike equity investments, convertible notes don’t require setting a valuation for the startup at the time of issuance, making them faster and easier to negotiate.
• A valuation cap sets the maximum valuation at which the note will convert, protecting the investor in case the startup’s valuation skyrockets.
• Protects investors by ensuring conversion at a favourable valuation, regardless of the startup’s growth trajectory.

Example: A $5M cap on a startup that later raises at $10M ensures the investor’s shares are converted at 50% of the funding value.

3. Interest

• Convertible notes typically accrue interest (e.g., 5–8% annually) called its coupon rate.  
• Upon conversion, the accrued interest often converts into equity alongside the principal adding to the investor’s stake. 
• This feature compensates for the time value of money.

4. Conversion Triggers

Convertible noteholders usually convert on the occurrence of a trigger event such as a funding round aligning returns with company success. Triggers are typically defined as:

• Qualified Financing: The note converts during the next significant funding round when the startup raises equity.
• Maturity Date: If no funding round occurs before the note’s maturity date, the noteholder may convert into equity or demand repayment.
• Liquidity Event: Conversion may also occur in the event of an acquisition or IPO.

If the note doesn’t convert by the maturity date (or if no qualifying event occurs), the noteholder can demand repayment of the principal and interest, although this is uncommon for startups.

5. Investor Risks

Startup Viability: If the startup fails to reach a trigger event such as raising the next round or achieving liquidity, the note may not convert, and repayment could be uncertain.

Subordination: In the case of bankruptcy, Convertible noteholders are often subordinate to other creditors

Convertible notes are attractive for startups needing quick funding and investors seeking flexibility. Key terms like discount rate, valuation cap, and interest rate should be carefully negotiated to balance risk and reward for both parties.

Simple Agreement for Future Equity (SAFE)

A SAFE (Simple Agreement for Future Equity) is a popular investment instrument for early-stage startups. SAFEs simplify early-stage investing by securing future equity without the complexity of debt instruments. It allows investors to fund a startup in exchange for future equity, typically issued at the time of a priced funding round. Unlike convertible notes, SAFEs are not debt instruments. Here are the key features:

1. Equity-Based Agreement

• A SAFE provides the investor with the right to receive equity in the company at a future date, usually during the next priced funding round.
• Unlike a convertible note, a SAFE does not accrue interest or have a maturity date.

2. Valuation Cap

Just like Convertible Notes, the valuation cap sets the maximum valuation at which the SAFE will convert into equity, protecting the investor and giving them benefit from favourable conversion terms in future funding rounds.

Example: If the cap is agreed at $5 million and the next round values the company at $10 million, the investor’s SAFE converts as if the valuation were $5 million.

3. Discount Rate

• SAFEs often include a discount rate, typically 10–25%, which allows the investor to convert at a reduced price compared to new investors in the next funding round.
• Example: If the next round price per share is $1 and the SAFE has a 20% discount, the investor’s conversion price will be $0.80 per share.

4. Conversion Trigger

• SAFEs convert into equity upon a trigger event, such as a:
  • priced equity round (e.g., Pre-Series A).
  • liquidity event, such as an acquisition or IPO.

5. No Repayment Obligation

• SAFEs are not debt instruments, so there is no obligation for the startup to repay the principal investment. Investors are essentially betting on the company’s success.
• If no trigger event occurs, the SAFE remains outstanding indefinitely (no repayment or maturity obligations).

6. Simplicity

• SAFEs are simpler and faster to execute compared to traditional equity agreements or convertible notes.
• Standardised terms make them attractive for startups and investors looking to avoid lengthy negotiations.
• Since SAFEs avoid repayment obligations, focusing entirely on equity upside, this reduces legal complexity, but requires faith in the startup’s future growth.

7. SAFE Types

• Standard SAFE converts based on a valuation cap or discount rate.
• Post-Money SAFE specifies the investor’s ownership percentage after the SAFE converts, making dilution more predictable for the investor.

• Some SAFEs grant pro-rata rights allowing investors to participate in future funding rounds to maintain their ownership percentage.

8. Founder-Friendly

• SAFEs are less burdensome for startups as they avoid interest accrual, repayment obligations, and complex legal requirements compared to convertible notes or traditional equity deals.
• No Guarantee of Conversion: If the startup does not raise a qualifying round or reach a trigger event, the SAFE does not convert into equity posing higher risk to investors.
• No Voting Rights: Until conversion, SAFE holders typically have no voting rights or influence over company decisions.

A SAFE is a founder-friendly, flexible, and straightforward instrument for raising early-stage capital. Its key features such as the valuation cap, discount rate, and conversion triggers balance simplicity for startups with potential upside for investors.

Debt Finance

Aside from SAFEs, loans, and convertible notes, startups have a variety other forms of debt financing available. Debt financing offers structured returns but lacks the exponential upside of equity investments. The options will also vary in structure and suitability depending on the startup’s stage, cash flow, and business model. Here’s are some of them and how they work :

1. Revenue-Based Financing (RBF)

• Startups receive capital in exchange for a percentage of future revenue until a predefined repayment amount is reached. No fixed repayment schedule; payments are proportional to revenue. Ideal for startups with consistent revenue streams.

Example: A startup agrees to repay 1.5x the loan amount by giving up 5% of monthly revenue until the obligation is met.

2. Line of Credit

• A flexible loan where a lender provides access to a maximum amount of capital, and the startup can draw funds as needed. Interest is charged only on the amount drawn. Useful for managing cash flow and short-term expenses.

Example: A startup secures a $50,000 line of credit but only uses $10,000 for immediate needs.

3. Bridge Financing

• Short-term debt used to “bridge” the gap between funding rounds or significant business milestones. Often includes high-interest rates or equity conversion options. Provides liquidity until a more significant financing event occurs.

Example: A startup can raise bridge funding to cover operating expenses until its next equity round.

4. Mezzanine Financing

• A hybrid of debt and equity financing, where the lender provides a loan that can convert into equity if not repaid. Higher risk than traditional debt, so it carries higher interest rates. Often used for scaling or pre-IPO stages.

Example: A startup raising mezzanine financing to expand into new markets.

5. Trade Credit

• Suppliers extend credit terms, allowing the startup to purchase goods or services upfront and pay later. Interest-free if paid within the credit period (e.g., net-30 or net-60 terms). Can support startups in managing inventory or working capital.

Example: A startup secures 60-day credit terms from a supplier to fulfil customer orders.

6. Venture Debt

• Debt financing provided specifically to venture-backed startups, typically alongside or shortly after an equity round. Complements venture capital by providing additional funding without further equity dilution. Lenders assess the startup’s growth potential rather than immediate profitability.

Example: A startup raises $2 million in venture debt to extend its runway after a Pre-Series A funding round.

7. Equipment Financing

• Loans or leases specifically for purchasing equipment needed for the business. The equipment itself serves as collateral. Useful for startups in manufacturing, healthcare, or tech requiring expensive machinery or tools.

Example: A startup purchases manufacturing equipment with a loan payable over five years.

8. Invoice Financing (Factoring)

• Startups can sell their unpaid invoices to a lender at a discount for immediate cash. Quick access to working capital. Lenders collect payment directly from the startup’s customers.

Example: A startup receives 90% of an invoice’s value upfront, with the remaining balance (minus fees) paid once the customer settles.

9. Microloans

Small loans provided by nonprofit organisations or microfinance institutions. Typically under $50,000. Designed for very early-stage startups or entrepreneurs with limited credit history.

Example: A startup secures a $10,000 microloan to launch its initial product.

10. Peer-to-Peer (P2P) Lending

• Startups borrow funds directly from individuals through online platforms, bypassing traditional banks. Competitive interest rates compared to banks. Often used by startups with difficulty accessing traditional loans.

Example: A startup raises $25,000 via a P2P lending platform like Funding Circle.

11. Corporate Credit Cards

• Startups use business credit cards to finance short-term expenses. Quick access to funds with flexible repayment options. Some cards offer rewards or cashback benefits.

Example: A startup uses a corporate card to cover travel expenses for a sales team.

12. Government Loans

• Startups access funding through government programs aimed at supporting innovation or small businesses. Often low-interest or interest-free loans.

Example: A startup secures a low-interest loan from the Small & Medium Enterprise Development Agency of Nigeria (SMEDAN) or similar initiatives.

So as you can see, startups can leverage a variety of debt financing options depending on their stage, revenue, and capital needs. Revenue-based financing, venture debt, and invoice factoring are particularly suitable for startups with growing revenue, while options like microloans or trade credit are better for very early-stage ventures. The choice depends on founders balancing risk, repayment terms, and the startup’s financial strategy.

Comparative Summary: Angel Investor Perspective

Feature	Straight Equity	Convertible Notes	SAFE	Debt Instruments
Risk/Reward	High risk, exponential reward	Moderate risk, flexible reward	High risk, delayed reward	Low risk, structured return
Control	Voting rights, board seats	Limited, but may include rights	No immediate control	No control
Liquidity	Exit at Acquisition / IPO	Exit upon conversion / trigger	Exit upon conversion/trigger	Repayment or cash flow basis
Complexity	Moderate	Moderate	Low	Varies

Conclusion

As an  early stage investor you should diversify Instruments and  balance your portfolio with equity, convertible notes, SAFEs, and debt to mitigate risk and capture various growth stages. Make sure you always assess founder alignment by understanding the startup’s vision and how that aligns with your investment goals. 

Make sure you leverage regional insights as Africa’s unique market dynamics often demand localised strategies. For example, investing in Nigeria’s Paystack was as much about understanding its local fintech customer demand landscape as about its global scalability potential. I trust that helps.