How early-stage venture capital can unlock socio-economic progress

by MMC
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South Africa, as the third largest and most diversified African economy on the African continent, holds immense potential for economic and social development. With its abundant natural resources, young population, resilient infrastructure and deep capital markets, South Africa can regain its position as a dynamic force on the African stage.

However, to fully realize this potential, critical challenges such as electricity shortages and unemployment will need to be addressed.

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A thriving start-up ecosystem can, as the South African Startup Act 2021 position statement advocates, “unleash the growth and innovation embedded in our entrepreneurs and youth” and accelerate socio-economic development, competitiveness and the transformation of economies.

The Start-up Act lobby group also focuses on the most pressing issues of concern to younger generations, given the relative youth of the founders. At the top of its list of priorities are issues related to energy transition and climate change, as well as their various consequences.

This is why we have seen, for example, between 2021 and 2023, funding for climate technology start-ups increase between 25% and 37% depending on the sources (The Big Deal and Partech respectively).

Seed funding is essential for a thriving innovation ecosystem

Historically, startup founders relied on angel investors in their circles of close friends and family. This situation was revolutionized in 2012 by US President Barack Obama’s Jumpstart Our Business Start-up Act (Jobs Act).

What do we mean by seed funding? Seed funding includes pre-seed (first funding a startup receives initially), seed (first formal institutional funding, raised in exchange for equity and typically used to launch into the open market) and pre-series A. (thin funding stage between seed stage and series A, to help start-ups gain more market traction and prove that the product is ready for growth and therefore ready for Series A financing).

This funding is essential for nascent innovations to take off, gain traction, and help start-ups prepare for successful fundraising to scale.

But the initial investment also comes with mentorship, a network of contacts and access to specialized industry knowledge, all essential elements for success.

In a country characterized by historic inequalities based on race and gender, equitable access to startup funding is crucial to building an inclusive entrepreneurial ecosystem.

Venture capital (VC) funding

The years 2020 and 2021 have been very encouraging in terms of venture capital funding: on the one hand, early-stage investments in Africa peaked in September 2020, at the height of the Covid-19 pandemic, given unprecedented demand for technological solutions such as power. and grocery delivery, edtech and healthtech.

Closer to home and following the trend, 2021 saw funding in the South African ecosystem reach its peak, placing the country second in terms of total funding to start-ups in 2022. But this has was short-lived: in 2022, funding for South African start-ups fell to fourth behind Nigeria, Kenya and Egypt, with seed funding particularly hard hit.

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The reluctance towards seed funding is not surprising: South African investors are known to be traditionally risk-averse. It is also true that in the recent past South Africa has become a higher risk investment destination – South Africa’s recent listing on the Financial Action Task Force (FATF) gray list , the persistent unpredictability and unreliability of electrical or logistics services, create an even riskier environment.

The savviest investors therefore diversify into other geographies (such as East Africa) and currencies that generate lower overall portfolio risks; however, this means that South Africa becomes an essential part of a risk-diversified portfolio, rather than a single investment destination.

Read: South Africa remains an attractive emerging market for investors

And even though the initial investment is risky, experts tout its benefits: not only do they offer the greatest return opportunities (according to Zachariah George, managing partner at Launch Africa Ventures, three to ten times the initial investment), but they are also essential for a viable pipeline of start-ups throughout the investment value chain.

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A changing environment – ​​fertile ground for start-ups in South Africa

A number of promising changes are afoot in South Africa, aimed at reducing risks to the local environment and supporting the systemic growth of innovation.

Promising progress has been made in promoting a Startup Act in South Africa. As the Startup Movement of South Africa puts it, “a Startup Act is essentially a piece of policy or legislation that aims to facilitate the establishment, growth and growth of startups.”

The recently released progress report for 2022/23 reports: During 2022, the public sector gained ground, with the introduction of the Sona (State of the Nation Address) announcement on visas for start-ups and President Cyril Ramaphosa’s reduction of red tape, among others. The successes achieved in Tunisia and Kenya are promising, and South Africa can greatly benefit from such a regulatory framework.

Read: Record fundraising campaign for African start-ups masks future challenges

The creation of the Innovation Fund by the Ministry of Science and Innovation in 2021, although recent, has already shown its first successes. It supports technological innovation and commercialization in high-risk technology development initiatives to balance the risk aversion of commercial investors.

Awareness of the importance of seed funding is growing and funds such as the University Technology Fund, ANZA Capital, Grindstone Ventures and Savant, among others, aim to fill this gap.

A call to action

Despite these promising first successes, we are far from having the critical mass necessary to have a visible impact. More resources, expertise and activity are needed. South Africa and other African countries can continue to gain momentum if, as a collective, early founders, investors, policymakers and development organizations focus on a combination of efforts.

This includes private sector Series B funds getting involved in seed funding earlier in the pipeline with emerging fund managers. This also implies that the public sector continues its efforts to establish successful public-private partnerships and a more favorable regulatory environment, such as better tax incentives to encourage early and angel investments and improving existing regulatory barriers with the various considerations outlined in the South Africa Act. Startup Law.

As the 2023 South African Innovation Summit approaches, the availability of capital takes center stage. Influential private equity and venture capital firms will come together to discuss the future of venture capital and investment opportunities, reflecting South Africa’s ongoing journey to unlock socio-economic development.

Listen to Small Business Conversations podcast host Akhona Matshoba speaking to Fezile Dhlamini, CEO of South African startup Green Scooter:

You can also listen to this podcast on iono.fm here.

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