An often-heard question among African entrepreneurs and investors is “does the Silicon Valley model work in Africa?” The Silicon Valley model meaning blitz scaling, raising big rounds, expanding fast in order to ensure you’re the quickest to land grab and the first to reach scale. Let’s look at some numbers:
For African start-ups, raising money from Silicon Valley-type investors is attractive, as investors are not shy of deploying big sums at attractive valuations. On the other hand, local investors usually take a different approach to speed, scale, and valuations.
Most African investors and business angels prefer for start-ups to raise smaller rounds. This allows companies to test the market, bootstrap, learn how to operate under cash scarcity, and hire like you’re spending your own money. This approach not only minimizes dilution, but also allows for trial and error and the establishment of a disciplined company culture.
As conservative as this approach may seem to US style VC investors, the rationale for this approach is rooted in the following understanding of the market:
The two approaches to venture investing pose an interesting rift in the market: on the one hand you have start-ups flush with cash, which is spent to find the user base with most growth potential, while not worried about profits. On the other hand, you see start-ups with similar revenues which are required to aim for profitability by operating on a much leaner budget.
The first company will enjoy higher valuations and more interesting headlines in the news for sure. The question that’s worth asking is whether its premium on valuation is driven by true potential value or by other factors.
Start-up success generally is measured by the size of the funding round, valuation, and how quick the company went from round A to B to C. The ability to run a profitable and efficient business will not make news headlines.
This perception of start-up success seems, at least in part, driven by investors. Most VC funds in Africa focus on Series A, and preferably Series B and would like to deploy at least $2-3M per investment. This preference, in turn, seems to be driven by investors into VC funds which prefer bigger funds focused on later-stage VC.
With not many funds focused on early-stage, start-ups are forced to raise bigger rounds earlier in their life cycle and move to Series A and B stage without having reached the underlying justified revenue levels and a solid business model.
For the entrepreneurs, this may be great news, as they make headlines earlier. However, the stage where entrepreneurs test their survival skills, working with little cash, and getting to proof of concept, is often skipped.
I believe that skipping the bootstrapping stage is a risky investment strategy and not what our market requires. It would be a pity if more companies fail than necessary, not because of a lack of market opportunity or capacity of the team, but due to investors’ deployment strategy.
When a business that was supposed to scale fails to deliver, investors will have to write off much greater sums than they would have in earlier pre-seed round days. Often time, investors end up throwing good money after bad money.
What is the right funding round, which stage are you in? Since my start in the VC industry in 1999 in Europe and moving focus in 2005 towards Africa I have worked with the following definitions:
To this date, the above definitions are serving us well in our work. Despite this framework, I won’t argue that the round sizes for companies like Andela or Zipline are overblown; as these companies have significant exposure to a US customer base, high valuations may be perfectly justified. And there may be other exceptional circumstances that allow for US-style venture investing in Africa. But I would still argue that these examples should be considered exceptional and not act as a benchmark for most African start-ups.
In general, I would advise entrepreneurs not to raise too much money too fast. Big funding rounds often come with unrealistic growth expectations, which burden the team, create unnecessary stress and high staff turnover. As appealing as it is to witness rapid growth, oftentimes slower growth is better for long term success.
Key benefits of a slower pace of growth include time to refine product offerings and adjustments to the business model, growing capacity to deliver, and having the runway to change course completely if needed.
Additional benefits are that companies which operate on lean cost structures are more resilient in dealing with unexpected but unavoidable shocks in the market, such as election unrest, droughts, currency volatility, economic downturn, etc. In Africa, it often serves to stay lean and mean and even downsize fast if circumstances dictate it.
Only when you have clear market validation, a balanced team and a good idea of the challenges ahead is it wise to add the rocket fuel and head for the moon. This usually takes longer than it would in any other market, but we see the patient and persistent investors and start-ups getting better and better at this.
Feature Image Courtesy: usnews.comThe article is authored by Eline Blaauboer, Managing Partner, Africa Tech Ventures and first appeared here.
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