Africa: Courting venture capital | World Finance Magazine

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African entrepreneurs, frustrated by political and economic barriers and the reluctance of banks, are increasingly looking to venture capital as the source of the funds they need.

Africans are enterprising people and enthusiastic about starting and running businesses. With a population of over a billion and a high proportion of young people, work is not a problem. But without capital to start up, launching new businesses is a challenge.

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

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

Acquiring capital outside the continent is also costly, as the minimum internal rate of return demanded by investors must offer them a significant premium above the rate of currency devaluation. Many African currencies are under pressure due to weak or unstable foreign currency production capacities. In Nigeria, the naira fell by almost 40% on June 14, when the central bank launched it, and its decline has deepened since. In Ghana, the cedi depreciated by about 35%.

Due to the difficult business environment in Africa, Ucheaga says, investors wanting to start generating profits sooner and at rates higher than currency depreciation may need to invest in multiple 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, says Ucheaga.

“The only people who will be willing to wait for you to go through all these difficult economic climates, be patient with you to gradually start increasing their profits in the years to come and give you that technical expertise of international best practices, are now becoming corporations venture capital,” he says.

Facing a funding gap

But Africa’s venture capital ecosystem faces a funding gap that must be filled before a new wave of fast-growing companies can materialize on the continent. Venture capital means investing in your own company or taking a high percentage of ownership, says Rossie Turman, chair of the international finance department and co-chair of the Africa department at Lowenstein Sandler, a New Jersey-based law firm.

“That fits well with a slow-growth or medium-growth company,” he says, “but it doesn’t fit well with a high-growth company where the expectation is that the people doing the work have a significant property.

To pave the way for foreign venture capital firms on the continent, African entrepreneurs will have to give up significant stakes in their companies – more than in more economically 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 venture capital ecosystem, says Turman.

According to figures compiled by the African Private Capital Association (APCA), foreign venture capital investments on the continent in the first half of 2023 fell by around 40%, with only $2.1 billion in deals completed on the entire continent, compared to $3.5 billion raised during the first half of 2023. same period last year.

“The decline in venture capital in Africa echoes the decline we’ve seen globally,” says Turman. “We then experienced a decline and Africa has certainly experienced that decline over the last two quarters.

Additionally, African entrepreneurs must decide whether it makes sense for them to seek venture capital. Some small and medium-sized businesses have the potential to transform into high-growth companies, others do not; but if venture capital providers want to invest, it has to be in high-growth companies, says Turman.

Some foreign venture capital firms do not have a good understanding of the African venture capital ecosystem, Turman adds, while carrying “all the prejudices that exist about Africa.”

That said, foreign investors are naturally concerned about the political and legal system of any country they wish to invest in, notes Austin Nweze, who teaches economics at Lagos Business School.

“They look for innocuous or semi-innocuous political systems,” he says, “because without adequate political stability, it’s a little difficult for the economy. If you look around you, how many African countries enjoy political stability or innocuous political systems? »

Another problem is the legal/judicial systems. Venture capitalists are concerned about how long it takes countries to address any legal violations that occur in business and corruption, says Nweze.

Africa needs venture capitalists because the current system in which banks fund startups is broken, says Nweze. Funds should instead be channeled to venture capital funds operating through banks.

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

Favored fintechs

African fintech startups continue to be popular among investors, according to the APCA report, receiving up to 25% of funding. This trend has been in place for about five years, Turman says, noting that they have remained consistent, which makes them attractive to investors. He attributes this to three key factors.

First, the investors themselves generally come from a financial background, so fintech does not require acquiring a lot of new knowledge to understand the model. Expertise may be needed to understand the solid minerals 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 has no bank accounts,” he notes, “and we need to attract people to banks. It’s an easy story to tell. The market is huge. The proportion of the African population that is unbanked is 50%. The third factor identified by Turman is “fear of missing out.” Many (investors) have missed something before; now they don’t want to miss anything.

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

“I’m a buyer and I think prices will go down,” he says. “I will wait until the prices come down. This is what venture capital firms do. They’ve raised a lot of money recently, so since they think prices will go down, why spend that money now when things are expensive and the prices of things will go down?

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