Getting the value out of venture capital

Africa’s leapfrogging in sectors such as mobile money and mini-grids is well documented. With the emergence of electric vehicles, satellite internet, and artificial intelligence, an abundance of leapfrog opportunities are on the horizon for venture capital investors.

However, Africa’s venture-backed unicorns including ChipperCash, Jumia, and Swvl, have struggled to maintain their unicorn status, while rising stars have faced layoffs and down-rounds. This volatile environment negatively impacts customers, jobs, and the ecosystem. If the next generation of African unicorns are to last, venture capitalists must shift away from demanding rapid, exponential growth and favor paced profitability as the model of success.

Rethinking economies of scale

The venture capital model hinges on the principle that scale equates to value. Investing in new markets for customer growth, and in tech for operational efficiency is the formula to create a large, marketable business. However, applying these premises to the African context can be misleading.

Africa is far from operating like a single economic zone. Expanding across borders often necessitates new bank and telco partnerships, customized application programming interfaces (APIs), separate logistics partners, and new taxes, licenses, and currency risk. Add in the diversity of customer behavior and language and achieving scale becomes far from straightforward.

Moreover, operational efficiency from scaling technology is not a given. African customers often prefer tech products that are complimented by human interaction because it fosters trust. Business-to-business (B2B) e-commerce players depend on sales agent networks to stay top of mind with their customers and fintech players utilize agent banking as a core part of their service. Plus, the African ecosystem is so nascent that startups must develop it as they grow, whether by purchasing their own logistics fleets, or acquiring financial licenses, or even establishing their own utility.

Scaling in African venture-backed tech is complex and carries the risk of inadvertently creating an operationally burdened and less attractive business.

Prioritizing resilience over speed

The venture capital model also places emphasis on speed. Capital injections are expected to graduate a company to the next funding round within 18 months. However, African businesses operate in environments where economic shocks constantly disrupt well-laid plans. Kenya, during the period of 2017-2022, provides a case in point.

The 2017 presidential election brought commerce to a halt for a year, as businesses shied away from investing until the contested results were known. Severe droughts and locust infestations over multiple seasons left millions foodinsecure and depressed consumer demand. The sudden introduction of a digital services tax and fluctuations in fuel levy policy added to the turbulent business environment.

On top of domestic shocks, external events brought more volatility. The change in the U.S. federal funds rate and the Ukraine conflict resulted in capital flight, currency depreciation, rising fuel and food costs, and inflation. Such frequent shocks mean that African businesses cannot plan too far ahead and must constantly adapt.

In this context, the traditional venture capital formula falters. Capital meant for fast growth often absorbs shocks instead. Resilience becomes the key to capturing return on investment. Investors and entrepreneurs must align on long-term value. The potential for resilience is evident in startups across sectors that have demonstrated consistent growth in value through several economic cycles, such as MFS Africa, Interswitch, Victory Farms, mPharma, and KOKO Networks.

By opting for a growth rate that does not significantly outstrip profitability, a venture can establish self-reliance, and the ability to withstand economic shocks without being at the mercy of external capital.

Establishing the next generation

Venture capital’s “spray-and-pray” strategy, which bets on one billion-dollar unicorn out of many initial investments, is not suitable for Africa. A formula that prioritizes slower but more likely-to-succeed ventures offers better returns on investment.

Development finance institutions (DFIs) are the largest investors in African venture capital via funds of funds. Germany’s DEG, The UK’s CDC, France’s PROPARCO, Norway’s NORFUND plus the International Finance Corporation (IFC), European Development Bank, and others committed $80 billion for Africa over five years. To truly fulfill their commitment of fostering job creation and economic independence, DFIs should adopt a sustainable funding philosophy, akin to that which family offices such as CreaDev and seed funds such as Future Africa have come to embrace from experience building businesses on the continent. Long-term investment partners can better assess growth in relation to sustainability. Structuring funds to allow for capital infusions at multiple stages of a venture’s maturity will vastly increase the odds of a viable exit.

If African investors can shift this paradigm, the valuable businesses they create will in turn become investors in their own ecosystem and nurture the next generation of African unicorns.