The creative industry has been described as a sleeping giant, a mass employment sector as well as a risky sector for investors. Be Afrika is always hunting for information that would best serve the creatives that we try to cater to. We would like to share an article by the African Tech Ventures on the Paradox of the African VC funding.

The ATV is a group of passionate investors and entrepreneurs who believe that scalable, innovative businesses are the drivers to economic growth and prosperity. That technology can accelerate the pace in which people gain access to essential goods and services.

The paradox

There is an overwhelming shortage of venture capital in Africa, and at the same time, investors on the continent complain there is not enough quality deal flow. Why?

The answer is quite simple: capital available for venture in Africa doesn’t fit funding requirements. What’s available is for stages of growth that very few companies reach because there is no seed capital to help them get to that level. If you are not funded at the earliest stage of your business, you will never be funded at a later stage.

The only way out of this unproductive cycle is for investors to invest at pre-seed and seed level and accept the risks that come with it. This can happen in two ways, and better yet, at the same time: funds to invest at earlier stages and more early stage angel investors who can take the risk to get involved.

Usually, enthusiasm among High Net Worth Individuals (HNWIs) in Africa has been marginal and local seed funds have remained infrequent. Fortunately this seems to be changing. A growing interest for early stage investments among HNWI’s and local family offices has been visible the past few years, resulting in increased deal activity.

A funding gap remains beyond the stage of angel investment. Though we believe this gap should be filled by venture funds who can participate in late seed and pre-series-A rounds, most fund investors are still unwilling to support this type of venture investing. The combination of Africa, the technology sector and early stage companies seem like a risky proposition that institutional money is not yet ready to support.

The opportunity

As understandable as this reluctance is, we believe like Africa Tech Ventures that an opportunity for venture funds exists specifically for two reasons:

  • if you start investing at this stage, there will be a significant increase to deal flow for traditional PE
  • at this stage there is a significant and growing opportunity for good investment deals

Here is what could be considered a perfect solution to all our problems: Funds will contribute to building pipeline for themselves and others by moving down the funding ladder. More companies, at the same time, will be able to grow large enough to be considered for investment by traditional PE funds.

Possible? We believe so, but we also accept that a slightly different approach is required from the fund investor as two key hurdles present themselves at this level; first, the amount of work is huge due to the size of the funnel. As we invest in about 1-2% of companies that we interact with, anyone working at this level will have to consent to a lot of work selecting the right investments.

Secondly, investee companies normally don’t have the kind of documentation and data that investors like to have before making investment decisions. Venture investors will have to rely in part, on good understanding of market potential and assessment of the capacity of founding teams, rather than on mature data sets and audited financials to make their decisions.

Supposing that you accept the higher risk, higher workload and limited level of data available when making investments, what could a venture portfolio look like? Our own track record will do to illustrate what is possible.

The example

Over the past 10 years ATV has been investing in East Africa, completing, among others, 12 deals in the technology sector. We made these investments both as a team under Safaricom Spark Fund (6 deals) and separately as either institutional or angel investors (6 deals).

The combined funds we invested in these 12 companies was around US 4.2m. Two companies received about USD 3m and the other ten on average USD 120,000 each. Selected from a pool of around 600 companies and representing 2% of companies seeking financing at the time.

In respect to our 12 portfolio companies, suggestions to date ranging from follow-on capital raised, to increase in valuation and operating performance show a positive growth trajectory for the portfolio. The average valuation increase has been over 3 times our initial investment.

In 2018 these 12 portfolio companies managed to raise USD 70m, bringing the total combined capital raised to date to about USD 120m. The ability to raise USD 120m over 7 years has demonstrated investor confidence in the growth prospects of the companies. It’s also a validation of the catalytic effects that early stage investments can have.

Early stage investment risk in Africa requires hard work and discipline. It also includes tough decisions about whether to support investee companies beyond seed stage. Some may not receive further investment to scale if critical KPI’s are not met.

Of the companies that reach the planned scale, some will deliver stellar returns. These returns would not be accomplished if we had only invested in Series B and onwards, which is where most funds operate at the moment.

As risky as investing in early stages companies in Africa may seem, we are convinced that our approach will contribute positively to building a thriving start-up ecosystem on the continent in the years to come.