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EU Startups Embrace Convertible Debt as Funding Grows Scarce

funding

With funding becoming scarce, European startups are reportedly turning to convertible debt.

These increasingly complicated deals are becoming more and more popular for venture capital (VC)-backed firms, Reuters reported Monday (March 18), though they do risk eventually giving investors greater control.

As the report notes, companies were able to conduct equity funding rounds at steep valuations when interest rates plummeted in 2020 and 2021. But with venture funding drying up, companies and investors have shied away from these rounds, as they could establish newer — and lower — valuations.

Enter convertible debt, which becomes equity over time and can help founders raise cash quickly without having to publish new valuations. According to Reuters, data from Dealroom shows that the volume of convertible debt issued by European venture capital-backed firms reached a record $2.5 billion last year, compared to $1.7 billion in 2022.

However, as these deals grow in complexity, they can provide greater benefits to investors and more liabilities for startups, Reuters said, citing interviews with attorneys, company founders and an investor familiar with the deals.

“If you don’t know what you’re doing, structured debt can be a Trojan horse,” said Ali Niknam, CEO of Dutch digital bank Bunq, who has raised via convertible debt at a previous company.

“If for whatever reason you don’t make it, and it gets converted, sometimes people lose control,” added James Wootton, a partner at law firm Linklaters.

Last year saw a major drop in tech startup funding in Europe, per a report in November by British venture capital firm Atomico. That report projected funds raised by Europe’s tech startups would reach $45 billion for the year, compared to the $82 billion those companies reaped the previous year.

“The decline is not surprising given the dual effect of many later-stage companies delaying fundraising, as well as materially slower deployment pacing by investors, which have both served to drive the large decline in the prevalence of outsized, late-stage investment rounds — the biggest factor in the lower amounts of capital invested,” the report said.

Meanwhile, PYMNTS last month examined the state of the startup/VC investment space as it relates to artificial intelligence and cryptocurrency.

“Nine out of every 10 startups that raise money end up failing over 10 years,” PYMNTS wrote. “At the same time, observers believe that venture-backed startups fail at higher numbers than the industry usually cites.”

It’s why, that report added, VC investors in the AI and crypto space seem to be more focused on infrastructure plays than before, with funding “being directed much less to service providers in favor of building foundational ecosystems.”