Venture Capital (VC) funding is one area that is severely hampering innovators from truly expanding like they could. Why is it that African VC funds just aren’t engaging? And what can be done to rectify that?
In my work with innovators on the African content, a trend I’ve picked up again and again is a struggle for funding. Many innovators may have done well in their country, and are in the position to successfully replicate their success and expand to other nations, but they are corralled by a lack of access to the right kind of funding.
When you think of the life-cycle of an innovative company, it usually starts from seed funding, where family and friends and the innovator themselves are putting in the funds to see it take off. From there the company is looking for venture capital (VC) funding, where it has a prototype product or service that’s done relatively well, or the business has a few stable clients, and the company wants to expand nationally or in another country. If the business grows (or survives!) through that phase, it moves to private equity – it’s now a sustainable business and can grow into a genuinely profitable business nationally or multi-nationally. The last phase, typically, is then to be listed or partner with a bank for financing.
It’s in the VC phase, however, that there seems to be a consistent problem on our continent. I think this is a real challenge that we need to address. The VC phase, in fact, is almost non-existent here, and this is a huge gap for innovators. A lot of innovators have to look beyond our borders and approach the likes of Silicon Valley, but this comes with all sorts of problems and misunderstandings about the African context, resulting in mismatched expectations from investors and a model that just does not work here.
I’ve recently started speaking to several VC and private equity funds on the market, as well as innovators, in an attempt to get to the bottom of this problem and see what we can do to rectify it. In the process of doing so I’ve picked up on two consistent trends:
1. Innovators have unrealistic evaluations, usually tempered by the fact that they have spoken to a Silicon Valley-like company or a European based company.The problem is the way these overseas companies and investors work is just not very workable here. Their approach to innovation funding is different. For example, they will typically employ an Uber-type approach: build an asset, throw lots of money at it, and hopefully in 6 – 10 years’ time the asset is so big that someone will buy it out. During that process, a lot of cash has really been blown, but the reality is that the sheer scale of innovators overseas makes this worthwhile.
See, in Silicon Valley this works because for every ten innovations on the table, one will take off and do very well, becoming the next Airbnb or Uber, and the sale of that asset will justify not only the investment into it but the investment into the other nine that have done relatively well, or are growing, or haven’t even done well. Here in Africa, however, we just don’t have enough innovators to justify this sort of model of funding – or the right amount of throughput to do so.
What works here is what I call a ‘convertible’ model. This is where a company is funded according to agreed milestones and targets, and maybe later down the line the investor has an equity stake in the business. But many innovators have approached the likes of Silicon Valley and have come back with what is essentially a crazy evaluation, expecting the same sort of approach here.
2. VC firms in Africa expect profitability very quickly.I think this makes a lot of sense, and if I were in their shoes I would be thinking exactly the same. If your business isn’t leaning towards profitability very quickly, it’s difficult to justify a constant investment. This is big money and if that money is put elsewhere, even into a bank, there are guaranteed returns.
While I’ve spotted these two trends I’ve also spotted two other things I find fascinating – and hugely encouraging.
1. VC funds actually want to play with innovators.And, of course, the innovators need the funding.
So what’s the problem? It’s quite simple.They’re just not connected to each other. They are just not talking.There’s a serious case to be made that VC funds need to engage earlier with innovators. Aside from the funding, they can also provide necessary expertise – give the innovator access to markets and networks; insight into how to grow; info on tech funds in the continent; and buttress all that with the actual funding.
2. Public entities, like SARS, really do want to participate.There’s an open secret on the Income Tax Act called Section 12J. This is actually an amazing opportunity for investors that I think many have no clue about, yet it was introduced by the National Treasury in 2009.
Section 12J allows an investor to put money into VC company funds and receive a tax exempt certificate. Invest a million or R100,000 and it’s tax free. It’s an ideal situation for small investment groups, corporate executives in a high threshold tax bracket, and, of course, companies investing into innovation. Find out more info about it at SARS [link:http://www.sars.gov.za/ClientSegments/Businesses/Pages/Venture-Capital-Companies.aspx] or listen or read this interview at Moneyweb [link: http://www.moneyweb.co.za/moneyweb-radio/save-tax-venture-capital-investing/].
This is a very clever way in which SARS is stimulating investment into start-ups, and innovation is obviously in mind here as well. A question I’m asking is how do you take this sort of model that SARS is pushing and replicate it, where investors hedge their bets due to an incentive such as tax relief, creating a pool of funds and investors that plug the gap between innovators and VC funding?
I don’t have the answer to that question. Yet. But I think we have the right starting point here. I also think that we have one major tool that we can employ right now and will make a huge difference straight away and it’s this:
To simply just talk to each other.