The Top 3 Stumbling Blocks to Funding African Startups
Excitement and interest in the African tech startup scene has grown immensely over the last few years. There are more stories about fundraising startups, such as Andela’s $40M dollar announcement1; startups being acquired, such as Getsmarter’s2 purchase by 2U; and new funds being launched, such as Partech’s new pan-African fund3. There is also more data on startup activity; Disrupt Africa4, Partech Ventures5, Venture Capital for Africa (VC4Africa)6, and WeeTracker7 all report on venture funding, including total investment amounts, sector activity, and geographical trends. Challenges have also been well discussed, from the dearth of capital for early-stage startups to the difficulties caused by gaps in logistical, financial, and connectivity infrastructure. Nonetheless, there are a few—defining growth ambitions, sourcing talent, and reaching scale—that are emerging as hot topics for discussion.
Fit to Purpose: Unicorns vs. Gazelles
At an angel investor summit hosted by ABAN (African Business Angels Network), SABAN (South African Business Angel Network) and VC4Africa in Cape Town last November8, a robust discussion emerged around what African startups could and should become. The default, based on Silicon Valley-esque expectations, is to aim for unicorn status, or a $1B valuation. Presumably, a more context-appropriate alternative is the pursuit of gazelle-hood9—to become a business that increases its revenue by 20% every year for at least 4 years. What drives this debate? The success of the LP/GP fund structure10 that is standard in many parts of the world is contingent upon producing a return that is at least 3 times11 the value of the fund within 10 years. Given how probable startup failure is, it’s unlikely that more than 1-2 startups within a portfolio will contribute to that level of success (by returning the entire value of the fund), under the best conditions. In Africa, where capital and talent are scarce and infrastructure is weak, the odds are even more daunting. Not surprisingly, Silicon Valley investors may seek larger valuations than what is typical in Africa, despite limited local knowledge of the market. This is problematic because local investors are likely to value startups differently, and the startups themselves might struggle to meet such expectations. As such, it’s reasonable to question how realistic (or useful) it is to aim for unicorns in Africa.
Of course, the debate about the value of African startups raises questions about the path to exit assumed by VC funds. Exit opportunities are a bit harder to come by in Africa. They are more likely to happen through acquisitions than IPOs. Also, given the complexity of African markets—infrastructure challenges, diverse operating environments, and questions about the utility of trends in GDP growth, mobile penetration, and consumer purchasing power—more time may be needed to generate desirable returns. As a result, one wonders how well the typical LP/GP structure will work in Africa. Only time will tell, but for now it seems that using this structure makes it easier to attract international capital.
Perhaps not surprisingly, capital sources don’t only affect fund structures, they also influence the paths that startups choose. For example, there has been vigorous discussion about the utility of “soft” capital, such as grants, as funding sources for African startups, especially in startup ecosystems like Nairobi where these funds are plentiful. Some “traditional” tech investors argue that grants encourage startups to focus on social impact related metrics that could distract from the pursuit of profit and scalability. The counterargument is that: 1) many impact investors, who typically seek financial and social returns, still emphasize business fundamentals; and 2) soft capital, which tends to be more “patient”, i.e. seeking returns over a longer time horizon, may provide founders operating under tough conditions more leeway to work through business fundamentals. This is particularly true if the funding is unrestricted, which enables startups to test critical assumptions about their business models. Additionally, although soft capital sources like grants are “cheaper” because the funds need only be returned rather than multiplied, they can also be costly due to the time and human resources required to administer, manage, and report on them. It’s also important to note that much of Africa’s soft (and traditional) capital sources are international, which begs the question, “where is the local funding in Africa?”
Generally speaking, VC funds need institutional investors such as pension funds to provide capital to invest in startups. However, few pension funds in Africa invest in VC funds due to their conservative investment strategies—many will invest in treasury bonds rather than in the private sector. Similarly, high net worth individuals (HNIs), of which there are a limited number (Africa has few billionaires), often prefer to invest in assets with large, predictable returns, such as land, oil, and financial services. This is where organizations such as ABAN come in—to help educate and encourage potential angel investors to provide early risk capital to startups. Additionally, there is a growing number of Africa-based funds—4DX Ventures, CRE Venture Capital, EchoVC, and Knife Capital—that are providing smart, local capital to early stage startups. But beyond gazelles, unicorns, and capital sources, what problems remain? In a word? Talent.
The War for Talent: More Demand than Supply
The difficulty of sourcing great talent affects funds and their portfolio companies alike. With respect to funds, talent is a challenge for a variety of reasons. First, because African VC funds tend to be small, the pool of capital from which its managers earn a management fee, called a carry (usually 2% of invested capital), is also relatively small. This means that the teams that run these funds are compensated less than their counterparts at sizable funds, and are likely to be smaller and multi-functional. Secondly, despite the compensation constraints, the time and energy required to source and conduct diligence on deals is significant. This is due to a difficult and complex business environment, as well as a limited pipeline of investable startups.
As such, finding the right people to confront these challenges may also present a challenge.
When it comes to startups, the landscape is equally difficult. Despite the growing pool of tech talent in emerging ecosystems such as Nigeria, recruiting and retaining people is still a problem for many companies. Proven talent can be expensive, and the best candidates will have access to other local prospects, as well as opportunities abroad. Additionally, management talent can be difficult to find. To combat this deficiency, VCs are starting to invest in cultivating talent. For example, Village Capital hosts a job board12 for its portfolio companies and offers an open source curriculum that startups can use to build their teams’ skills. Now, assume a stellar African startup has the right growth goals, funding and talent. There’s yet another variable to consider—the pursuit of scale.
Achieving Scale: Pan-African Startup Where Art Thou?
Whether African startups aim to become gazelles or unicorns, the markets in many African countries (with the possible exception of giants such as Nigeria) are too small, complex, and fragmented to solely support the aggressive expansion of an ambitious startup. As such, many of these ventures will look beyond their countries or regions, perhaps to the rest of the continent and beyond, to drive growth. Not surprisingly, expanding beyond local markets is difficult due to the need to understand business culture, navigate legal and regulatory frameworks, and secure talent. Additionally, companies in large markets such as Paga in Nigeria are charting a path to growth that maximizes local expansion first, which means capturing market share in a megacity like Lagos before expanding to other cities and/or countries where there are exploitable market opportunities.
Of course, it’s difficult to speak credibly about pan-African expansion when the conversation seems focused on Anglophone startups. For example, Afrostream13, a Paris-based14, subscription-on-demand service that provided unlimited access to African and Afro-American movies,15 expanded into 24 African and 5 European countries before it shut down last year16. Generally speaking, Francophone startups seem to be less visible than Anglophone ones. The picture is somewhat sunnier in North Africa, with Egyptian VC Algebra Ventures raising $40M in 201617 and companies such as on-demand courier app Bosta18 and social video analytics platform Minitrics19, raising funding20. But what can one say about ventures in Central or Lusophone Africa? Perhaps the launch of Partech21[20], a $100M pan-African fund with offices in San Francisco, Paris, Berlin, and Dakar, offers hope to digital startups located outside of hubs such as Kenya, Nigeria, and South Africa. Even so, there is plenty of room for startups from across Africa to grow and expand throughout the continent.
https://qz.com/1099774/andela-40-million-series-c-local-founders-can-look-to-raise-more-funding-from-african-vcs/
http://ventureburn.com/2017/12/sa-tech-startups-acquisitions-revealed-2017/
https://qz.com/1186803/partech-africa-launches-100-million-fund-for-africa-startups/
http://disrupt-africa.com/2018/01/investment-into-african-tech-startups-hit-record-high-in-2017/
https://www.linkedin.com/pulse/another-record-breaking-year-african-tech-start-ups-raised-collon/
https://vc4africa.africa-newsroom.com/press/vc4a-research-proves-founder-teams-are-key-to-startup-success-in-africa
http://weetracker.com/2018/01/02/african-startup-funding-report-2017/
https://vc4a.com/aais2017/
https://www.investopedia.com/terms/g/gazellecompany.asp
Generally speaking, LPs, or limited partners, invest in the fund. GPs, or general partners, run the fund.
http://avc.com/2009/03/what-is-a-good-venture-return/
https://vilcap.com/careers/#portfolio
You can read the founder’s excellent post mortem here: https://techpoint.africa/2017/09/22/afrostream-shut-down/.
https://www.crunchbase.com/organization/afrostream#section-overview
https://www.crunchbase.com/organization/afrostream#section-overview
https://techpoint.ng/2017/ http://disrupt-africa.com/2017/06/egyptian-social-video-analytics-platform-mintrics-secures-funding/ 09/22/afrostream-shut-down/
http://disrupt-africa.com/2016/12/algebra-ventures-raises-40m-to-invest-in-tech-startups/
http://disrupt-africa.com/2017/03/egyptian-courier-app-bosta-raises-funding/
http://disrupt-africa.com/2017/06/egyptian-social-video-analytics-platform-mintrics-secures-funding/
http://disrupt-africa.com/2017/12/top-5-egyptian-startup-developments-in-2017/