Africa: Wooing Venture Capital

African entrepreneurs, frustrated by political and economic barriers and reluctant banks, increasingly see VC as the source of the funds they need. 

Africans are enterprising people with a zeal for starting and running businesses. With a population exceeding a billion people with a high youth segment, labor is not a problem. But without capital to start them, launching new businesses is a challenge.

 “The problem of capital is not even the lack of it; it is the price of it. Capital in Africa is very expensive because inflation is very high,” says Emeka Ucheaga, CEO of EUA Intelligence, a Lagos-based financial consulting firm with expertise in macroeconomic and global market analysis.

In Nigeria, inflation is currently 24%; in Ghana, it is 32%; and in Angola, 12%. This explains the high interest rates prevalent in most of the continent. In Nigeria, Africa’s biggest economy, the monetary policy rate—the rate at which the central bank lends to banks—is 18.75%.

Sourcing capital from outside the continent is also expensive because the minimum internal rate of return that investors demand must give them a significant premium above the currency devaluation rate. Many African currencies have come under pressure due to low or unstable foreign earning capacities. In Nigeria, the naira fell by nearly 40% on June 14, when the central bank floated it, and has fallen further since then. In Ghana, the cedi has depreciated by about 35%.

Because of the difficult business environment in Africa, Ucheaga says, investors wishing to start generating profits early and at rates higher than currency depreciation may have to invest in several companies. These challenges are further compounded by inadequate infrastructure, and insufficient government support for businesses, he adds.

This creates a vital role for venture capital, Ucheaga argues.

“The only people who will be willing to wait for you to punch through all these harsh economic climates, be patient with you to gradually start raising profits in years to come and give you that technical expertise of best practices internationally, now become VCs,” he says.

Facing A Funding Gap

But Africa’s venture capital ecosystem faces a funding gap that needs to close before a new wave of fast-growing companies can materialize on the continent. VC means investing in one’s own business or taking a high ownership percentage, says Rossie Turman, chair of the International Finance practice and co-chair of the Africa practice at Lowenstein Sandler, a New Jersey-based law firm.

“That matches up well with a slow-growth business or a medium-growth business,” he says, “but that doesn’t go well with a high-growth business where the expectation is that the people who are doing the work are going to have a meaningful ownership.”

Opening a path for foreign VCs on the continent will require African entrepreneurs to give up significant stakes in their businesses—more so than in economically more developed countries—to get the capital they need, says Ucheaga.

What African governments, policymakers, and long-term African investors need is to develop their own models, for which they will invest in the VC ecosystem, Turman contends.

According to figures compiled by the African Private Capital Association (APCA), foreign venture capital investment into the continent in the first half of 2023 fell roughly 40%, with only $2.1 billion worth of deals occurring throughout the continent compared to $3.5 billion raised in the same period last year.

“The drop in Africa VC echoes the drop-off we saw globally,” says Turman. “We had a pullback then and Africa has definitely seen that drop in the last two quarters.’

Additionally, African entrepreneurs must decide whether pursuing venture capital makes sense for them. Some small to midsized firms have potential to burgeon into high-growth companies and some may not; but if VC suppliers are going to invest, it must be in high-growth companies, says Turman.

Some foreign VCs lack a proper understanding of the African venture capital ecosystem, Turman adds, while carrying “all the biases that are out there regarding Africa.”

That said, foreign VCs are understandably concerned about the political and legal system of any country they want to invest in, notesAustin Nweze, who teaches economics at Lagos Business School.

“They are looking for political systems that are benign or semi-benign,” he says, “because without proper political stability, it’s a bit difficult for the economy. As you look around, how many African countries have political stability or benign political systems?”

Legal/judicial systems are a further issue. Venture capitalists worry about the length of time it takes for countries to dispose of any legal breaches that occur in business and about corruption, Nweze says.

 Africa needs venture capitalists because the current system in which banks fund startups is broken, Nweze argues. Instead, funds should be channeled to VC funds operating through banks.

“Banks don’t understand the kind of risks entrepreneurs take,” he says. “They cannot even manage them; they cannot give entrepreneurs the kind of attention they need. But if you have a venture capital firm, it can come in and take a seat on the board.”

Fintechs Favored

African fintech startups continue to be popular among investors, the APCA report found, receiving as much as 25% of funds. This trend has been in place for about five years, Turman says, noting that they have been consistent, making them attractive to investors. He attributes this to three key factors.

First, investors themselves typically come from a finance background, and so fintech doesn’t require them to acquire much new knowledge to understand the model. Expertise may be required to understand solid minerals that are needed for computer chips, or clean energy, but not the business plan.

The second driver of fintech is the large number of unbanked Africans, says Turman. “The whole of Africa is unbanked,” he notes, “and we must get people to the banks. That’s an easy story to tell. The market is huge.” The fraction of Africa’s unbanked population is 50%. The third factor Turman identifies is “the fear of missing out. A whole lot of [investors] missed out before; now they don’t want to miss out again.”

How quickly they will respond is a more difficult question, however, and the answer may not be specific to Africa. Foreign VC activity on the continent has declined in line with a global trend, Turman notes, and this general macroeconomic trend that has affected all the regions.

“I am a buyer and I think that prices will go down,” he says. “I will wait for prices to go down. That’s what the VCs are doing. They raised a lot of money recently, so since they think prices are going to go down, why spend the money now when things are expensive and when prices of things are going to go down?”