This article was originally published in Proparco’s magazine, Private Sector & Development.
Many factors are conspiring to establish a vigorous venture capital (VC) market in sub-Saharan Africa. A growing number of VC teams have recognised investment opportunities, driven by large underserved African markets, the ability of entrepreneurs to design innovative business models that leverage the high penetration of mobile technology, a lack of legacy infrastructure and increasing spending power.
Development finance institutions (DFIs) and private capital, including family offices and high net worth individuals (HNWIs), have started to support this asset class. A maturing technology and entrepreneurial ecosystem is emerging in Nairobi, Lagos and Cape Town, fuelled by mobile money, growing demand for products and services, and the innovative solutions African entrepreneurs are bringing to vast, underserved markets.
Yet, is mobile technology the key to solving Africa’s problems? Will startups scale-up fast enough to serve local markets? Is there enough talent? Do investors, entrepreneurs and VC investment teams have realistic return and time horizon expectations? And why the lack of African unicorns – VC-backed startups that reach a valuation of US$1bn in a financing round or exit – for many the evidence of a quality, functioning VC market?
The answers require a data-driven perspective of African VC markets and a knowledge of the key factors and behaviours of stakeholders that are most conducive to generating value for VCs.
Young and small VCs
Many regard 2010 to be the beginning of the African VC ecosystem. In 2014 significant exits of VC-backed companies were realised. Until recently, African VCs were sporadic and unmeasured: metrics became available only in 2015, when it was estimated that $185m to $277m of capital was invested in 55 to 125 startups (Disrupt Africa, 2016).
Estimates of the size of VCs in Africa in 2017 varied between $195m and $560m of capital invested in 128 to 160 deals (Partech Ventures, 2018). In the same period, the US VC market generated $72bn invested in over 5,000 deals; China, $71bn in over 2,800 deals; Europe, $18bn in about 2,500 deals.
The average holding period of a VC investment in the developed world is between five and seven years, often longer for investments resulting in high returns. VC-backed African companies have just started to complete their first life cycle from seed to exit. Hence, the African VC ecosystem is young and small, and it is unsurprising that it has not yet resulted in a string of positive exits, the basis for predictable returns.
Africa’s yet-to-be-generated unicorns
Unicorns indicate a VC ecosystem that is ripe for investment. In Q4 of 2017, CB Insights (2017) published its most recent report on unicorns, recording a global total of 214, with 106 outside the US: 52% were in China, 9% in India, 8% in the UK, 4% in Germany, 3% in South Korea, with the remaining 24% in other countries.
Compared with their US, Asian and European counterparts, these companies have not followed traditional VC paths: funding has come primarily from public companies and private sponsors, which tend to back mature companies, with typical private equity expectations.
African unicorns are possible
With these questions as a framework, the prospect of Africa generating unicorns is optimistic. There are three reasons for this.
First, Africa offers gigantic underserved markets. Most of the demand is low-income, necessitating business models based on low-cost positions. Technology can enable these. A similar opportunity exists in the B2B space. Low-productivity SMEs need affordable technology solutions, while value chains can also benefit from technology-enabled solutions. Consumer-facing corporates also need mobile-based enterprise software to better segment, serve and increase their customers.
Second, African companies and entrepreneurs are comparable to other countries. The ratio of investable companies to the total deal flow in Africa is similar to other regions. However, entrepreneurs live in a less mature and supportive ecosystem, resulting in longer times to financing, or to adjusting or giving up on their business models. Also, less guidance from angels, VCs, consultants and repeat entrepreneurs can result in business models that are less market-driven and business fundamentals-oriented, and more focused on brilliant tech. Management and technology talent is also scarce. However, these obstacles are balanced by advantages peculiar to Africa. The technology risk is lower because entrepreneurs tend to create business models that leverage proven technologies and there is a more predictable exit path associated with large private equity funds.
Third, there is a growing supply of early stage and growth capital, and related business-building support. Sources of capital for African entrepreneurs include seed-stage financing rounds of up to a few hundred thousand dollars; for mature companies looking for growth/expansion, rounds of $10m or more are typically served by mid-market and private equity funds. The gap is in the $500,000 to $10m range, which is typical of series-A and B venture capital financing. Companies such as Andela and Twiga demonstrate that fast growth in large, underserved markets via tech-enabled business models is taking root in Africa. But these companies have tapped the global VC market in the series-A to B range.
Africa has attractive markets and companies that can scale, but unicorns need sufficient local capital and business-building capacity, which come with VC.
Increasing odds for African unicorns?
The imperative is to invest capital and discipline to create a sizeable and professional local commercial VC industry. This is the responsibility of limited partners who recognise the Africa VC opportunity or who have room for a less-proven asset class in their global allocations, and VC teams who need to build high-risk, high-return portfolios validated by subsequent financing rounds at growing valuations, and by value-generating exits.
Also, a business fundamentals culture driven by an understanding of industry dynamics must be embraced by VC teams and entrepreneurs. African entrepreneurs and their startups must be held to the same rigorous standards as their worldwide counterparts. Declining an investment in – or unplugging from – a failing company is as critical as supporting a winner. Attracting more capital to African VC involves generating success stories. Even with investment only in potential winners, there will still be failed investments.
Business fundamentals should be adopted early in the lives of companies, creating realistic expectations in young teams about the availability of capital, investment requirements and valuations. Local governments can also make a difference by creating a supportive environment through regulation, tax incentives for VC investment, and building economic stability to attract more capital.
Ultimately, the key value generator is the entrepreneur. It is up to VC teams to fulfil capital market expectations by serving the needs of the entrepreneur for business building, talent support, and guidance, from financing to exit. If we can nurture a new generation of African VCs focused on these values, Africa will generate her share of unicorns.
Maurizio Caio is the founder and managing partner of TLcom Capital.