Venture capital funding has led the most investments on the African continent since 2016. Even with COVID-19 dealing a hard blow on the economies of many countries on the continent and affecting startups’ revenue in 2020, VCs still led funding activities in that year.
Despite VCs’ dominance of funding activities, a new report by advisory firm Kinyungu Ventures found that there is a mismatch between Silicon Valley investing conditions and African market realities.
According to the report, venture-backed opportunities are built on the premise of a thriving middle-class in Africa. However, the reality is that Africa’s middle class is much smaller than projected and their purchasing power is also not as significant as most investors assume.
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The Brooking Institute suggested this in its 2018 report in which it projected that more than half of African households would have discretionary income by 2020 and noted that consumer expenditure had grown by a compound annual rate of 3.9 percent between 2015 and 2019. Notwithstanding, household spending trails incomes. Also, BMI Research’s dependency index shows that having dependents reduces economic power for Africa middle-class consumers. For example, the average Nigerian consumer might be responsible for up to eight people.
VCs also fail to recognise that consumers in Africa prioritise the price and utility of a product. Low purchasing power means that the cheaper the product the more incentive consumers have to spend. Consumers also tend to spend their limited incomes on products or services that add value.
Additionally, investors don’t realise that consumers in Africa are expensive to acquire and difficult to retain. Hence, founders have to bear the high consumer acquisition costs that may not even guarantee the high lifetime value of the customer.
One of the reasons for the high consumer acquisition cost is because of access to far-reaching digitally enabled distribution networks.
“First, consumers are rarely amenable to fully digital distribution methods, preferring “tech touch” approaches that create trust by embedding human interaction. For example, African e-commerce businesses were initially challenged to reconcile African human interaction-heavy shopping norms with shopping cart-oriented Western practices, which were digitized and used as a template for e-commerce. As one investor explains: People can’t run with tech. For example, for a telemedicine platform, in Western markets, access is at your fingertips,” the report read.
African markets are different in that founders have to address the trust issues consumers have before even onboarding them on their platforms.
But founders may also overestimate the digital literacy of their customers, especially those in the rural communities. These consumers may also not willingly want to try new products because they are not easily given to changing what they know for what they do not know.
Investors may also want to consider that because startups lack the infrastructure to penetrate consumers at the grassroots, they will not have the first-move advantage compared to big corporations like telecommunication companies and banks. These corporations are more likely to have the capital to invest in building large, mass-market distribution networks than startups do.
The researchers also argue that the fragmentation of African markets makes it more challenging to expand outside home markets. At the same time, the poor state of infrastructure makes it more expensive than expected to build Africa startups because of the costs associated with building distribution networks and supply chains.
Fundamentally, VCs need to realise that what works for Western tech startups would not necessarily work for African startups. Silicon Valley VC is designed to support high-growth companies hence it requires outsized returns that African markets cannot necessarily provide at the same scale due to the market dynamics.
But Silicon Valley VCs’ adventure in Africa hasn’t been all gloom and doom, at least from 2019 when new funding into startups on the continent began to translate into more exits. Notable examples include DPO Group acquired by Network International; Sendwave by WorldRemit; WeBuyCars by Transaction Capital; and Paystack by Stripe among many others.
The mismatch between VCs and African founders is however having a positive resolution in which startups and funds on the continent have adjusted their operating models to better align with the realities of the market: startups, by tackling problems in foundational sectors such as agriculture running lean operations, and expanding earlier than their peers in other regions; and funds, by favouring B2B companies and established use cases, investing post product and market fit, and aiming to build a portfolio of modest winners, rather than a few absolute home runs.
“Finally, some funds are experimenting with adding fixed income, debt assets, and PE-type SMEs, which have lower risk profiles and more predictable return patterns, to cross-subsidize their direct equity investments. For example, Collins Onuegbu of the Lagos Angel Network described the utility of creating a portfolio composed of revenue-generating companies as well as those using revenue to scale,” the report noted.