One of the long-running tensions in the African startup investment ecosystem has been whether the Silicon Valley funding model, which seems to have been transferred wholesale to Africa’s very diverse and different tech hubs, is right for the continent’s tech hubs at this stage in their development.
With the disproportionate influence of Silicon Valley investment on Africa’s top tech hubs in Lagos, Nairobi and Cape Town, this debate isn’t going away anytime soon. And even where there are local tech investors many have adopted the expectations of their better funded American counterparts.
A new white paper, Chasing Outliers: Why Context Matters for Early Stage Investing in Africa by East African venture advisory firm, Kinyungu Ventures, examines those tensions and tries to explain how what it terms “African market realities” and “startup characteristics” should set the ground rules that influence how Africa-focused startups and funds should behave.
African markets’ common characteristics of price sensitivity and low purchasing power clash with an expectation of Silicon Valley-style high growth and super returns while startups have much fewer options for capital to drive that growth. This leads to “mismatches” say the authors.
For example, startup founders around the world often talk about “scaling up” as they start to grow. It’s shorthand for achieving economies of scale thanks to the benefits of the internet and technology, where your unit cost to produce a widget decreases as you produce even more widgets. However, it doesn’t necessarily always work out like that in many African markets, in fact there could be diseconomies of scale due to poor infrastructure with everything from weak internet connectivity to poor road networks and low financial inclusion.
For this reason, many African startup founders focus on “trying to solve large, foundational problems that could improve the lives of countless people”; building infrastructure such as supply chains and fintech platforms; pursue mass markets across Africa; and leverage local knowledge.
The challenges with low financial inclusion and outdated banking technology and payments systems in some African countries with large consumer bases has meant huge investment has been put into startups addressing these problems. Nigeria’s Paystack was bought by Silicon Valley’s Stripe; Visa invested in Lagos-based Flutterwave and Goldman Sachs has led investment rounds in South Africa-based fintech firm Jumo and Lagos-based logistics startup Kobo360. Fintech in particular has dominated African startup investment for several years now.
That’s why the authors, who spent a year interviewing over 100 founders and investors from 15 countries, say despite some of these mismatches and concerns on whether to invest in African markets, “a more measured perspective is that significant, profitable opportunities exist despite, and arguably because, of the challenges.”
These will be found by engaging “large, unexploited markets”; discovering huge opportunities through experimentation and stellar execution; and leveraging mobile infrastructure and nuanced local knowledge to digitize and organize analog markets.
“While African markets aren’t always able to provide the outsized returns that Silicon Valley typically looks for in high-growth companies, a more focused strategy here could unlock real gems, as has been proven by some of the startup successes the continent has seen over the years,” says Tayo Akinyemi, lead researcher on the paper.
If there is one core message from the paper it’s that Africa’s startup ecosystems need to adopt norms, structures, and processes that reflect the realities of operating in Africa. Nowhere is this more essential than in the funding structure of venture capital and other investors.
The paper makes the case general partners of funds need more flexible structures to better cope with markets that are evolving as rapidly as most African ecosystems. These include using alternative instruments and structures, such as debt or permanent capital vehicles (PCVs), which work by offering an unlimited time horizon for recouping return.
Another approach could be having a more focused investment approach such as B2B investments or more mature companies for example. Ultimately, investors need to reconsider their assumptions and biases. “What is clear now is the need to respect the context in which funds and startups operate and use it as a foundation to develop appropriate fund and company building norms,” write the authors.
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