South Africa’s Startup Scene Battles Seed Gap & ‘Exit Paralysis’

With foreign venture capital investment into Africa falling 43 percent, according to one estimate, during the first half of 2023, Grindstone Ventures, a notable startup development programme, partnered with other VCs, investors, fund managers and the SA government to try to address the startup funding deficit facing the region.

“Seed and post-seed funding remains a big challenge for startups across Africa,” Catherine Young, the Managing Partner of Grindstone Ventures told an audience at a round table held at the SA Innovation Summit in Cape Town at the end of September 2023.

The meeting resolved to ensure better collaboration between pre-Series A investors, as well as greater participation between investors, government and big corporations to stimulate the local startup sector. Together with the collaborative, Grindstone Ventures pledged to initiate deal structures that make it easier for investors to enter
and exit startup markets in Africa.

The other panellists in attendance included Young’s long-time partner at Grindstone Ventures, Keet van Zyl, the Partner and Co-Founder of Knife Capital, as well as Audrey Verhaeghe, CEO of Anza Capital; Kadir S. Gungor, Chairman of Dubai’s Sustainable Impact Capital Holdings; Tishanya Naidoo, Principal: Venture Capital at 27four Investment Managers; and Konanani Rashamuse, Chief Director of Innovation Instruments at South Africa’s Department of Science and Innovation.

Young detailed the key issues raised by investors. “The first big issue is exits. Venture Capital at the seed stage is high risk so investors want to see quicker exits.” She said funders wanted bigger funds to join, and were sceptical that VCs could quickly mature, diverse teams that generate real value. “The big issue was the recent greylisting of South Africa. This really hindered fundraising with potential investors offshore,” she said.

Grindstone Ventures’ Young spoke about the struggle to find funds. “Our experience taught us that for every ten reachouts to potential LPs, we had one interested in learning more,” said Young, speaking about the struggle to raise funds.

“At Grindstone Ventures we had a longlist of 88 potential LPs which was shortlisted to 66. Out of this number 48 matured into pitches. Only 20 of those who pitched were invited into follow-on discussions. Ultimately there were only six final pitches, proved the one in ten ‘rule’ we anticipated,” she said.

Van Zyl whose Knife Capital has successfully exited 14 companies revealed that exit paralysis was prompting asset allocators to consider alternative, less risky investments like real estate or stocks. The veteran VC said protracted exits “eat up returns which make it difficult to raise follow-on funding rounds.”

Verhaeghe, CEO of Anza Capital, which initiated the roundtable, spoke to the lost opportunity cost of not resolving the funding crisis: “Pre-seed to Series A funding is the beginning of industrialisation. Never mind the job creation that you
lose out on, this is where new ideas are, the creative energy that builds the knowledge economy,” she said.

“If you don’t invest in the early stage, you lose that capability in your economy. You are creating a big gap, which makes you an import economy instead of an export economy. We are not solving our own problems. That is a massive opportunity cost if we don’t get this right,” she added.

Young told the audience what Grindstone Ventures was doing to ensure the survival of its cohort: “We’re continuing to fundraise while helping the startups in our portfolio to earn revenue so that we can actually just show traction as a proof of viability. We’re taking a two-pronged approach by courting investment and ensuring our portfolio companies focus on revenues and market access to achieve a good track record,” she added.

The proactive group agreed to collaborate to unlock some ZAR 1.4 T (~USD 72 B) on the balance sheets of big corporations in SA and beyond. The investors also called on universities to liberate endowments to stimulate startup activity and pledged to look at how the Johannesburg Stock Exchange, Africa’s largest bourse, could be used to enhance liquidity.