Perspectives on early stage venture capital in Africa

Despite COVID, the deals are marching on!

In 2020, tech startups in Africa raised over $1.5 billion in 400+ funding rounds, with a further $1 billion in M&A activity. Although the amount of capital deployed was down -30% compared to 2019, due to ticket sizes being slashed as Africa dealt with the effects of the global pandemic, the continent remains the world’s fastest growing VC market with activity growing by 50%. The first half of 2021 has already seen greater deal volumes than the first halves of 2019 and 2020 combined!

The pace at which investors are placing long term bets on how technology will transform the region and create long term value, is increasing. It is evident that not only is the ecosystem resilient, but it is even getting a boost from an accelerated digitalization of some key economic sectors. 

Vauban is fortunate to work with some of Africa’s leading venture investors who’ve kindly offered to discuss themselves, their investment strategies, general trends, challenges and opportunities on the continent. We hope you enjoy their insight!

First in the series we have… Zachariah (“Zach”) George,  who was there at the genesis of the African VC industry.

Zach is the Founder and Managing Partner of Launch Africa Ventures, and Chief Investment Officer of Startupbootcamp Afritech. After graduating from Stanford, Zach cut his teeth with 7 years on Wall Street as an investment banker, working for Lehman Brothers and Barclays Capital. 

Since moving to Africa in mid 2010, as an Angel investor, he’s invested in 50+ leading African tech startups including Flutterwave, KudaBankYocoRecomed and several others.

I was very grateful to catch up with him:

How did the story start and what was your first investment on the continent?

I started Angel Investing back in 2014 before people really knew what Angel investing was! My first (and one of my best) classic tech angel investments was Flutterwave, which has become one of Africa’s very first unicorns. At the time they were just a payment processor, but with impressive 10% WoW transaction volume growth. They’d also gotten into YCombinator, which was very rare at  the time. Most people in Africa didn’t even know what YC was and only a couple of African businesses got in each year. Now that number is closer to 15 or 20.

And I thought to myself that if I don’t start backing tech companies like this, at the start of the VC industry, I’d never catch up. I didn’t want to wait four or five years, which is where a lot of VCs today are coming in. A lot of people want to be VCs now but they’ve missed the opportunity to work with founders directly.

VC in Africa tends to have a private equity-driven mindset, albeit with smaller chèque books. And that’s not what venture capital is about at all. 

I continued like this with high volume, small ticket Angel investing for two to three years. This gave me a line of sight to some of the continent’s top founders and the credibility to eventually build a global accelerator (Startupbootcamp Africa) with Philip (Kiracofe) and now to launch my first proper fund. 

Tell me about Launch Africa, what differentiates it in terms of strategy?

Our fund is laser focused on Seed Investments; unlike other funds, we don’t have an allocation for Series A or Series B follow-ons. Our sweet spot is companies at the post MVP/ Seed stage that are looking for expansion capital to get to Series A. We love working with founders directly and helping build their product and service, but we’re not helping ideate and validate businesses, as an accelerator does. 

Our focus means we can invest in a lot more companies than other funds do; most funds set aside a lot of capital to follow on their earlier investments, but we don’t have that constraint of missing out on a good company just because we didn’t have the capital. Secondly, our fund has a five to seven year life cycle with a two year deployment period, as opposed to your typical ten to fifteen year fund with a five year deployment period.

We have this because our exit strategy is not predicated purely on IPOs or M&A; it is driven by secondaries to a large extent. We have the option (where available) to take money off the table when companies raise their A or B rounds which is very attractive to individuals, family offices and retail investors. They don’t typically have the luxury of investing like DFI’s (Development Finance Institutions), who can hold onto their capital for 10 to 15 years.

Fundamentally, we believe that if you recycle and rewash your capital every five years, then you have the opportunity to invest in more innovative companies. Investing in a company and hoping for an exit in ten years, when the industry changes every few months, is a big dichotomy! 

We also allow our LPs to co-invest with us for free, which is a huge differentiating factor as it permits really good founders at the seed stage to raise more capital in a shorter period of time. As Launch Africa, we typically lead a deal and our LPs will co-invest with us alongside other regional VC funds and Angels, which gives founders more time to focus on operations and growing versus just fundraising. We also allow our LPs first access to invest in future rounds, even though we don’t follow on, which is music to their ears!

We are a pan African fund, but because of our deep relationship with the large accelerators, e.g. Startupbootcamp, YC, Plug and Play, Founders Factory, etc., we’re able to engage local VCs, who are more likely to join a round if we are involved. A lot of the tech and legal DD is done by the accelerators, which makes us efficient.

Overall, our reach and deal sourcing is super efficient. A lot of the time spent evaluating investments is taken away because we’re very strategic; we only do SAFEs, and CLNs. As we don’t invest in common equity, we don’t have to spend time negotiating subscription and shareholders agreements. 

What do you provide to the companies you invest in other than capital?

We’re very hands on and help with talent acquisition and recruiting. One of the most underrated and most important things in an early stage company is getting talent and it’s crucial in all areas of the business.

It’s also very hard for founders to open up in new countries themselves, but we have great relationships with large corporates such as banks, retailers, insurers, telcos etc, which are needed when you’re trying to scale internationally.

We help founders with introductions to later stage funds and also have 25 to 30 advisors in our advisory pool, who may join the board of a company if there is a mutual fit.

If as an early stage VC fund, you’re not doing anything more than just capital, you shouldn’t be in this industry.

What are the biggest challenges to raising capital for an African focused fund?

To a large extent it is about perceptions. The investing world to-date has typically perceived African investment opportunities to consist of either: a) resource-heavy industries invested in by private equity such as infrastructure, mining, oil and gas, power, heavy industry. Or b) foundations and aid groups / charities. There has been nothing in the innovation and technology space until five or six years ago.

And largely, perceptions around geopolitical risk, currency risk, infrastructure, project debt and asset financing risks are exaggerated.

However, venture capital as an industry is different because technology cuts across multiple layers and most tech startups don’t cut into government contracts or large regulations. If they do, they’re usually growth hacking their way out of it and trying to go direct to consumers via intermediary channels like distributors. 

The main challenge is when people start painting venture capital with the same brush as private equity or asset financing in Africa. However, once you have investors that have done Angel investments and seen the returns, that tends to go away.

Setting up a Spotify in South Africa or an e-commerce platform in Kenya is like doing so in any other part of the world. The beauty of tech and early stage investing is that, to a large extent, you don’t have the regulatory compliance and hurdles that other later stage businesses have.

There’s a lot more in common between a tech startup in Africa and San Francisco, versus a mining company in the U.S. and a mining company in Africa.

What are the structural hurdles Africa-based managers face

There are a couple of structural things to keep in mind. Most African funds are either set up in Mauritius, the US, or Singapore. Most of your LPs, especially if you’re a VC fund, tend to come from Europe, the US and Asia, so a USD or EUR fund makes more sense. 

Investors are also more comfortable if the IP of the companies you’re investing in sits outside of the opco; most companies that operate in Nigeria, Kenya, South Africa etc, have a holding company off the continent, which owns 100% of the operating company. 

If you’re a Nigerian company, you want to create jobs locally, pay your taxes locally, but investors want to be investing in a country that has favourable double taxation treaties, favourable capital gains tax, favourable IP control laws.

This arrangement works; the local governments are happy because taxes are paid locally. The economies are happy because jobs are created, and the investors are happy because the money is actually going into an overseas entity. So when they want to exit prior to a liquidation event, it’s easy to take money out of a UK or European or an American domiciled company. 

What makes venture in Africa different to Europe or the US?

It’s very hard to scale a B2C business in Africa, simply because the cost of acquiring customers is extremely high, for obvious reasons; the low penetration of the internet and higher data costs

But when you work with banks, insurers, telcos and retailers from a distribution standpoint, the cost comes down dramatically. They will do all the heavy lifting for you in exchange for a licence fee, a JV pilot or a proof of concept. I classify Latam, Southeast Asia and Africa in one bucket as they have similar B2B and B2B2C business models. Whereas in Europe, Asia, India, China, and the US, B2C models tend to work better. 

The other difference is that valuations pre-series A are ridiculously low in Africa due to a huge shortage of capital at that stage. You barely have Angels coming in at that stage, and not much smart capital, so valuations tend to be depressed.

I’d say the average delta between a seed stage startup in Africa vs Europe is probably 40%, and we take advantage of that. Kudabank for example should have never had a valuation less than $10 million, even at pre-seed. Equalisation then happens at series A or B- for example Kuda has just raised at a $500 million valuation for its Series B.

Sophisticated investors get the arbitrage opportunity but more institutional investors such as pension funds and asset managers still shy away from Africa, unless it’s listed equity; there are plenty of ETFs. But when it comes to private capital and Africa, outside possibly property funds, there isn’t really much understanding, so investors that have not been in the space are hesitant.

What are the interesting sectors for you over the next 5 years?

We’re very excited about edtech, healthtech, mobility, logistics, and broadly speaking, food and water security, which comes through agtech. 

Fintech and to a certain extent insure tech had its heydays from 2015-2017 when a lot of the well known and now large fintechs such as Flutterwave, MFSChipper Cash etc launched.

Fintech was very important from a birth of the industry standpoint because Africa has 54 countries and each country has its own payment systems, infrastructure business practices and rules and regulations. Once that was solved and these businesses scaled internationally, it had a domino effect of starting a boom in other related industries, as entrepreneurs were able to think about leveraging other technologies on top of the payment stack.

For example in mobility and logistics, companies like Sokowatch or Twiga Foods were able to grow. Although you might think that they mainly rely on GPS and location tracking ability, the secure payment gateway was a necessary first.

Healthcare, not just because of COVID, has a need for huge industry innovation and disruption in areas like telemedicine, transportation of medical goods and services, cold chains, electronic health records. Microinsurance/ microhealth within these are very significant sectors.

Edtech is probably the third most important industry and has many sub components, from K-12, tertiary, online content and vocational training. And from a product perspective, (and I know that they sound like buzzwords) but you can’t ignore AI, ML, blockchain and IoT, In addition to robotics which is largely linked to AI. So those are the sectors we will be looking at.

And what about Crypto in Africa?

I’m not a fan of speculative trading and I do believe governments are going to clamp down on it as the path of least resistance. Anything that bypasses a centralised banking system is going to be seen as a threat. Outside of the speculation around alt coins, which is a separate topic, the concept of using blockchain and the decentralised ledger is definitely going to be a way in which many African consumers and businesses can get around.