• Monday, June 17, 2024
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How Nigeria can get more from $1.5bn start-up funding

How startups can adopt right strategies to reach target audience

Nigeria’s tech ecosystem may have had 2021 as its best year with more than $1.5 billion recorded in investment, but a significant portion of that total funding did not enter into the Nigerian economy, experts say.

Apart from the talent that comes mostly from Nigeria, tech companies source equipment and infrastructure abroad, the two claiming a large share of the funding. Also, with the majority of the foreign investors coming from abroad, the decision for what is allocated to each segment is made from the company’s headquarters, mostly abroad where the companies are incorporated.

“The good thing about venture funding is that there are tight milestones attached to the money,” notes a tech founder who pleaded anonymity. “This means there are agreements about what the money will be used for. However, it is a double-edged sword and if things don’t go the way you planned it, it can be disastrous. This is the reason it is critical for startups to have good governance from the beginning to keep them honest and focused on the reason for raising funding.”

A report compiled by Maxime Bayen, senior venture builder at BFA Global, and Max Cuvellier, head of mobile for development, GSMA, shows just how busy Nigerian tech companies were in 2021. The report found that whereas fintech companies dominated the funding scene, one in every five dollars raised in 2021 was by a Nigerian fintech startup.

OPay, a company that has its roots in Nigeria, took the largest slice of the funding with its record haul of $400 million. Nigeria also recorded three unicorns, Flutterwave, OPay, and Andela, the first of its kind by any African country in a calendar year.

Experts attribute the record funding to five factors. The first is Nigeria’s population size. It is really tough to ignore a market of 200 million people, even though the size of the middle class may be smaller relative to what is obtainable in more developed economies. The second factor is that venture capital firms will continue looking for new markets as the Western economic growth potentials flatten.

More Nigerian companies and founders getting into global accelerators, an indication of the high quality of the founders in the ecosystem, is attributed as the third factor. The fourth factor is that Nigeria’s largely untapped economic potential makes it a good place to test hypotheses. It may be a tough environment to succeed in, but it also has a high mobile penetration, which is an indication of access to digital products.

The final factor is the growth of the fintech space and many fintech startups have done well to project their continental and global ambitions.

Nevertheless, a vast majority of the companies that received funding in 2021 have their headquarters located outside the country, despite their primary market being Nigeria and other African nations.

Flutterwave (raised $170m, for example, has its main office at 1323, Columbus Avenue, San Francisco. OPay ($400m) was incorporated September 24, 2019, with a registered office at 19 Cheetham Hill Road, Manchester, England, M4 4FY. Andela ($200m) sees itself as a US company with ‘campuses’ in Nigeria and other African countries. TradeDepot ($110m) is primarily located in San Francisco, CA, United States, and is part of the Computer Systems Design and Related Services Industry of that country. Kuda Bank ($80m) was primarily incorporated in 2015 in London.

Experts say where a tech company is primarily incorporated is very significant for its operations. The ability to secure funding easily is one of the reasons. Foreign investors, which made up about 80 percent of the total funding raised by Nigerian companies, would have found it difficult to commit their money, especially in large sums to tech companies with primary bases in Nigeria.

Read also: How 10 Nigerian startups have fared after Y Combinator funding

One reason for this is the unpredictability of macroeconomics in a country like Nigeria. For example, the country’s inability to control the exchange rate is a big turn-off for many investors. Other problems like multiple taxation, poor digital infrastructure, and high inflation are some of the reasons tech companies run abroad to incorporate.

Quite a number of the companies that secured funding in 2021 were incorporated in Delaware, a small mid-Atlantic US state that sits on a peninsula, for a reason. A US venture capital investor often prefers Delaware startups because of the several classes of stock that Delaware law allows. The law gives preferred stock investors of a corporation certain voting rights and control over the corporation. Many venture capitals (VCs) insist on the Delaware corporate form and will even require a startup to convert the current entity to a Delaware C Corporation before they are willing to invest.

A startup registered in Delaware is taxed as a C-Corp. A c corporation (or C-corp) is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. Often these Delaware corporations come with 10 million shares of common stock authorised with $0.0001 par value. Most of these corporations issue half of the shares to founders.

These corporations are seen as well-adapted to VC and angel investing over other forms of business entities.

Importantly, US VC investors typically set standardised procedures for their investment activities and often require Delaware corporations for their investment targets. For instance, Y Combinator, a US seed money accelerator founded in 2005, requires that international startups they invest in are registered in the US as well as in their local countries. Y Combinator has invested in 30 Nigerian companies so far some of which include Paystack, Flutterwave, Cowrywise, Termii, and many others.

Although many of the funders may genuinely want their funds to help develop Nigeria and the African continent, they are first businesses and want great returns. Investors also want security and peace of mind, this is why most times they insist on founders incorporating in friendly jurisdictions that would not make bad decisions, states a source in the industry.

It is equally important to note that institutional investors, some of which came into the African funding scene for the first time in 2021 are not angel investors. They are interested in the company meeting all the agreed milestones so that the next valuation is much higher and they can exit at a great position if that is the strategy. To ensure this becomes reality, many of them would take board positions, track the performance and push for growth.

In insisting startups are incorporated within their jurisdiction, the investors are trying to mitigate two risks: the risk of company failing and business environmental risks. The first kind of risk is tackled in different ways and can work out very well, just good or bad. But the business environment risks are more straightforward. Nigerian and most of Africa have bad perceptions and structural problems including poor tax structures, profit repatriation and low reputation for ease of doing business.

“At the end of the day, the government must decide to either play the good game or lose out,” says a source that would not be named, to make him speak freely.

“The elephant in the room is that most of the best-funded startups are headquartered in other climes. This reality will have consequences in future liquidation events.”

Iyinoluwa Aboyeji, founder/managing partner of Future Africa, tells BusinessDay that the Nigerian economy benefits from talent recruitment, however, noting the risk of more of the money being spent abroad. The risk could also affect talent recruitment, where without a concerted effort to engage the universities to deliver more industry-ready talent, companies could be forced to outsource their development to other countries.

Aboyeji says Nigeriads to hire qualified talent at all levels. Who in the education sector is specifically delivering talent for this purpose,” he asks.

Companies will also need more sophisticated financial services; especially given they have raised funding in dollars and would want to manage exchange rate risk much better. In this regard, Nigerian banks could come up with dedicated help desks for startups that have raised millions of dollars.

Aboyeji also notes that startups will need new kinds of real estate and infrastructure to scale.

“I remember the CEO of a global payments business that bought a Nigerian company recently asking over breakfast, ‘where can I put 1000 engineers in Lagos’?” All of a sudden I realise that indeed there is no facility for that.

It was one of the reasons we decided to build Talent City, which is basically a city-scale infrastructure designed for tech companies and their employees to live, work, and play, he states. “We can go on and on. But the biggest determinant of whether Nigeria benefits from these funds is whether captains of industry and government wake up from their slumber, and design strategies to serve the industry properly,” he says.