East Africa’s evolving venture capital industry
By Niraj Varia, partner at Novastar Ventures
When we set up Novastar seven years ago the concept of venture capital in East Africa was a slightly crazy idea. Impact investing was one thing but it took a long time to convince investors that it was possible to deliver impact and financial returns at an early stage. Today, that argument has been made and the market is undoubtedly maturing.
Two prevailing trends point to this growing maturity. First, we see specialisation amongst both investors and start-ups. Early on there was an attitude of “we don’t know if it’s going to work, let’s be open to anything and give it a go”; today firms are singular in their focus. A great example on the investor side is Mobility 54, a corporate VC backed by Toyota Tsusho Group, which invests solely in mobility solutions for Africa. In turn, Africa-based entrepreneurs have zeroed in on sophisticated solutions to endemic problems. In the past few months alone we have spent time with 10 electric vehicle companies, two companies using AI applied technologies, and a score of marketplaces working to disintermediate broken supply chains. Meanwhile, as we know, fintech is thriving. This level of entrepreneurial activity, and the growing sector expertise that sits behind it, is good news for the East African venture ecosystem and ambitious businesses across Kenya, Uganda and Ethiopia.
The second indicator of market maturity is an increasing separation between impact and venture funds. In the past, if you invested early stage you were probably an impact investor whereas now there are increasing numbers of investors, both individual and institutional, who believe you can invest early to make money. Similarly, there are investors trying to have impact by doing more than just investing in SMEs. The industry no longer lazily bundles ‘early stage’ as impact and venture.
African venture capital is emerging as a distinct asset class. Venture is a very different animal to private equity; our work is not about the deep analysis of a single company in a sector and its financials but rather a judgement of individuals and teams. Almost by definition anything that we get excited about has huge amount of potential and almost no track record. That demands a different way of thinking and a particular sort of investment team.
And there is something distinctive about venture in Africa compared to more developed markets. This is a set of countries where there is massive untapped opportunity in every sector, and challenges in every part of the value chain. The entrepreneurs we work with seek to boldly transform the continent in a fundamental way – to change the way pharma works or disrupt the fertiliser industry, to come up with a new model for agri procurement or introduce innovative sanitation models in overcrowded informal settlements. Through our investments, we show it is possible to be equally committed to the financials and the impact. In our geographies, commercial success and impact at scale are mutually reinforcing because the companies we back are fixing huge problems, not making incremental gains in established industries. This impact finds voice in the stories of customer – whether that’s a family in Kibera getting on to the internet for the first time, a newly married couple buying a sofa for their new home, or a schoolboy being able to access a safe, clean toilet on his way to school.
A couple of examples help demonstrate the opportunity we see every day. One is NewGlobe Education, which started in Kenya expanded into Uganda, and today operates in five countries with over 2,000 schools and more than 780,000 current active pupils. Novastar was one of the first investors in NewGlobe and we’ve since been joined by the Chan-Zuckerberg Initiative and US VC firm NEA, amongst others. A second example is Komaza, whose unique microforestry approach pays farmers to grow tiny plots of trees for wood. Komaza does three things: it generates commercial return, brings enormous social benefit to farmers and their families, and sets up a unique environmental impact story. Both NewGlobe and Komaza share tech enabled operating models and work directly with low income communities on extraordinarily thin margins. These are themes which unite the Novastar portfolio and capture our thesis that you can secure tremendous social impact as well as strong financial returns.
We are not fundraising at the moment, but during the past 12 months we have definitely seen a spike in inbound interest from places like the West Coast, Hong Kong, Singapore and Europe as firms seek co-investment opportunities. This confirms East and West Africa is slowly being recognised at a global level. In turn, the DFIs are increasingly setting up their own internal venture arms, for example British International Investment. Their comfort with the ‘risk’ of venture in Africa now feels secure.
In 2014, Novastar set out to catalyse a new asset class in East Africa. We bear the scars and have the learnt the lessons from the 22 investments we have made since then. Our strong networks have brought in co-investors behind us, both third parties and our own LPs. We remain utterly true to our mission: to back amazing businesses which serve the common good, make money and as a direct consequence transform entire sectors. But we cannot do it alone.
More and more companies are providing early stage funding, be they angels or venture funds, but securing series A and B funding in East Africa remains very tough. Finding an investor willing to write the US$8 million – $15 million cheques needed to support rapidly growing but still unprofitable businesses is hard work. The second challenge is debt, start-ups in East Africa have to raise a lot more capital than they should because they are financing growth – capex or inventory, using equity. In addition, all of our companies have to try and fix entire value chains as they scale; this makes them more capital intensive as they have to iterate more and build much more expertise in their teams. That is why the series A and B rounds are so crucial. We welcome new entrants to this market. The handful of exits that have taken place so far are a cause of unique celebration; over the next three years, there will be more, enough, we think, that they will become cause for routine celebration.”
This article was first published in the East Africa Private Equity Industry Survey, produced by EY and EAVCA.