As any entrepreneur working to build a fast-growing business in Africa knows all too well; there is an overwhelming shortage of venture capital in the region. At the same time, investors on the continent complain there is not enough quality deal flow. How is this possible?
The simple answer is that the capital available for a venture in Africa does not fit the business funding requirements. Capital is available for stages of growth that most companies never reach because seed capital to help them get there is not available. If you are not funded at the earliest stage of your business, you will never be funded at a later stage.
To break this unproductive cycle, investors need to invest earlier and accept the associated risk. This can happen in two ways, preferably both at the same time: funds need to invest at earlier stages, and more Angel investors should get involved who can take the earliest risk.
Traditionally, High Net Worth Individuals (HNWIs) in Africa have demonstrated a low-risk appetite and local seed funds have remained scarce. Luckily the trend seems to be changing. The last few years have shown a growing interest in early-stage investments among HNWI’s and local family offices, which has resulted in increased deal activity.
Beyond the stage of angel investment, a funding gap remains yet. We believe this gap should be filled by venture funds who can participate in late seed, pre-series-A rounds. Unfortunately, it seems that most fund investors are still reluctant to support this type of venture investing. The combination of Africa, the technology sector and early-stage companies appear to be a risky proposition that institutional money is not yet ready to back.
Although this reluctance is understandable, our experience at Africa Tech Ventures indicates that:
- the deal flow for traditional PE will significantly increase if the funds and VCs start investing at this (early)stage
- the opportunity for good investment deals at this stage is significant and growing
By moving down the funding ladder, funds will contribute to building a pipeline for themselves and others. At the same time, more companies will be able to grow large enough to be considered for investment by traditional PE funds. Doesn’t that sound like a perfect solution for all our problems?
We believe so, but we also recognise that a slightly different approach is required from the fund investor as two key hurdles present themselves at this level. In the first place, the workload is high due to the size of the funnel. Given that we invest in about 1-2% of companies that we interact with, anyone operating at this level will have to accept a lot of work selecting suitable investments.
Secondly, investee companies typically lack the kind of documentation and data that investors like to access before making investment decisions. Venture investors will need to accept that investment calls rely in part on a sound understanding of market potential and assessment of the capacity of founding teams, rather than on mature data sets and audited financials.
Assuming that you accept the higher risk, higher workload and limited level of data available when making investments, what could a venture portfolio look like?
Over the past 10 years, our team at ATV has been investing in East Africa, completing among others 12 deals in the technology sector. We made these investments both as a team under Safaricom Spark Fund (6 deals) and separately as either institutional or angel investors (6 deals).
The combined funds we invested in these 12 companies was around US 4.2 Mn. Two companies received about USD 3 Mn and the other ten on average USD 120,000 each. These investments were selected from a pool of around 600 companies representing 2% of companies seeking financing at the time.
Regarding our 12 portfolio companies, indications to date ranging from follow-on capital raised, to increase in valuation and operating performance show a positive growth trajectory for the portfolio. The average valuation increase has been over 3 times our initial investment.
In 2018 these 12 portfolio companies managed to raise USD 70 Mn, bringing the total combined capital raised to date to about USD 120 Mn. The ability to raise USD 120 Mn over 7 years has demonstrated investor confidence in the growth prospects of the companies. It’s also a demonstration of the catalytic effects that early stage investments can have.
Taking early stage investment risk in Africa requires hard work and discipline. It also includes tough decisions about whether to support investee companies beyond the seed stage. Some of them may not receive further investment to scale if critical KPI’s are not met.
Of the companies that reach the planned scale, some will deliver stellar returns. These returns would not be accomplished if we had only invested in Series B and onwards, which is where most funds operate at the moment.
As risky as investing in early stages companies in Africa may seem, we are convinced that investing in early-stage startups will contribute positively to building a thriving ecosystem on the continent in the years to come.
Note: Boldewijn Sloet is the Founder and Managing Partner at Africa Tech Ventures. The views/opinion expressed are solely of the author’s. The article first appeared here and has been republished with permission.