Inadequate funding affects Africa start-ups

Ihub offices in Nairobi. The office houses most tech startups in Kenya

It’s not in doubt that African start-ups are losing out on the lucrative investment opportunities to their European counterparts enjoy. This has been an issue of heated debate in the technology sector for some time now.

Studies into the multi-billion-shilling venture capital ecosystem, as well as anecdotal reports from industry insiders, have revealed an investor bias against enterprises founded and run by indigenous African men and women working primarily in the continent.

This concern was once again thrust into the limelight at the TechCrunch Startup Battlefield tech meet last week in Nairobi.

The event was sponsored by influential technology news site and social media giant Facebook, and it was the first time TechCrunch was bringing its popular pitching competition to Africa.

At the event, 15 companies – selected from more than 700 applications – competed for a chance to win $25,000 (Sh2.6 million) in prize money and an all-expenses-paid trip to the US’ Silicon Valley to compete at the global Disrupt San Francisco 2018.

Not in play

But right from the onset, the issue of inadequate financing for African companies came up, with key speakers highlighting the differences in opportunities for start-ups in developed and developing countries.

“I was in the Bay area for 15 years, and when you are investing there, there’s a surplus of star entrepreneurs and a lot of money. Africa wins on the markets, and to a lesser degree, on venture-fundable entrepreneurs, but is not in play when it comes to the financing,” said Eghosa Omoigui. He is the founder of EchoVC Partners, a seed and early-stage venture capital firm operating in Lagos, Singapore and California.

“Vibrant ecosystems that are technologically driven require several important components, including markets, entrepreneurs and financing.”

According to the Venture Capital Pulse, done by accounting firm KPMG, venture capital-backed companies globally raised a total of $40.1 billion (Sh4 trillion) in the second quarter of this year.

However, the entire African continent is missing from the list of 2,985 deals attributed to this windfall.

The report further indicates that more than half of global venture capital funding last year went into the Americas (59.9 per cent), with start-ups in Europe and Asia taking up the rest (at 26.1 per cent and 14 per cent, respectively). Africa is again missing from this classification.

Some stakeholders in the industry have, as a result, pointed out that venture capital in sub-Saharan Africa is further below the ‘nascent stage’ that many project.

“I think there’s too little foreign capital coming into African companies,” said Sacha Poignonnec, the CEO and co-founder of online store Jumia.

“We are at stage zero of the venture capital journey in Africa, and we need to make it bigger. There are too few examples of success and we need more.”

European founders

However, besides the overt discrimination against the region’s entrepreneurs by global venture capital, foreign investors have also been known to have a bias for start-ups led or run by European founders, or Africans connected to foreign markets by education or association.

A study published by Village Capital established that out of 60 deals signed with tech start-ups in East Africa between 2015 and 2016, and valued at Sh8.5 billion, 72 per cent of the deals went to just three companies.

Further, 90 per cent of start-ups funded in East Africa over the same period were headed by at least one European or North American founder.

Village Capital spoke to dozens of investors, board members and entrepreneurs in East Africa and India, and what emerged is a rare account of a biased elimination process that unjustly locks out a majority of the continent’s start-ups.

In the first place, investors seek out companies that match a ‘profile’ of start-ups that they have seen or encountered in Silicon Valley.

“Because of the high cost of early-stage due diligence in India and East Africa, investors often fall back on pattern recognition to find companies and make investment decisions – relying on networks and indicators like attending a prestigious university or accelerator programme,” notes the report in part.

This is made worse by the fact that investors prefer start-ups that are staffed by skilled personnel before promising any funding. This is often difficult to achieve for entrepreneurs who are starting out with limited finances and are unable to pay even the founders.

Many start-up founders are pressured to include co-founders, partners and board members that are either foreigners or connected to the Western markets by higher education or association.

Six out of the 15 companies that competed in last week’s Startup Battlefield fronted European co-founders to deliver their pitches.

A majority of the rest had received their undergraduate or graduate studies from overseas universities, including Stanford and Leeds.

Cycle of bias

According to Rebecca Enonchong, the founder and CEO of AppsTech, a global provider of enterprise software, the problem is rooted in the structure of the global venture capital industry and not just localised in Africa.

Rebecca has worked as an entrepreneur for more than 15 years and is a private investor in African start-ups, which means she has seen first-hand the bias investors have towards firms led by indigenous African men and women.

“There are these networks even here in Africa where most people who have been in the tech space for a few years all know each other,” she says.

“What we see in the larger global tech space is this exclusive ‘I put you on my board, you put me in your board’ thing, and this is where all the decisions and all the investments are made.

“I spend a lot of time in Silicon Valley and I notice that even though I might be on the board, I’m not at the birthday party, I’m not at the negotiation table for the next round and these are the important events.”

This creates a situation where all the heavy capital financing circulates around a few privileged start-ups, with the same individuals strategically positioned in the top shareholding and boardrooms of these companies.

Local gap

On the flipside, investors have blamed a lack of adequate goodwill and low-risk appetite among local investors, which creates a vacuum.

“The challenge is that venture capital is brand new to the market,” says EchoVC Partners’ Eghosa.

“This is an asset class, and local investors get to pick and choose what they want to invest.”

This means that when presented with the option of investing in a risky long-term venture capital fund or investing in consumer goods or real estate, most investors opt to put their money in the latter segments, citing higher short-term returns.

“Investors can price risk, but they can’t price uncertainty and that is why it’s important to have local investors because they understand these dynamics and the long-term goal of owning these markets,” Eghosa explains.

His sentiments were echoed by Tayo Oviosu, the founder and CEO of Paga Tech, one of Nigeria’s leading mobile payment services.

“The biggest challenge when starting out is getting funding, and at some level as Africans, we should want to see local entrepreneurs develop and run businesses and be the face of businesses on our continent,” he says.

“But at the same time, if local investors are not investing and local entrepreneurs do not have the base of people to run these opportunities, then there is nothing wrong with foreigners coming in and hiring people because benefits accrue to the economy.”

Fixing it

Tayo further gave the example of his own company where a majority of the capital has come from abroad, enabling his firm expand and hire staff.

“We are in the beginning stage of the investment lifecycle in Africa and we need examples, and sometimes it takes foreigners to come in and do these things first and local investors to see it and realise that they are missing out.”

This means local investors need to look at start-up financing as a long-term asset class alongside traditional investments like property and securities.

Government regulators could also offer incentives that promote investment from local funds, such as tax rebates similar to those provided to firms investing in the country’s export processing zones.

At the end of a full day of panel discussions and pitching, Kenyan start-up Lori Systems emerged the winner of TechCrunch Startup Battlefield and the Sh2.6 million prize money.

The logistics company uses big data to analyse and predict cargo traffic, cutting down operational costs for transport firms and cross-border traders.

“Logistics play a big part in increasing the overall cost of commodities, and the cost can sometimes be three times over what you could’ve paid in other places like the US,” says Joshua Sandler, the founder of Lori Systems.

His firm has created a smart fleet-management system able to anticipate operational hitches and avert these by directing trucks to where they are most needed in real time, with drivers and turnboys feeding information into the system through WhatsApp and Facebook Messenger.

Joshua says Lori Systems has clocked Sh600 million in system-wide revenue and is moving more than one million kilogrammes of goods a day.

“Our core customers control over 50 per cent of the fertiliser industry in the region, and some of our customers include Pembe, Cargill and Unga Group, and our customer retention is 100 per cent so far.”