Grace Ashiru
In the past year, African tech startups faced considerable challenges. Securing venture capital proved to be a daunting task, aligning with earlier predictions. Bridge and down rounds became increasingly common, while reports of fire sales, staff layoffs, and startup closures spread throughout the continent.
Initial reports indicate a significant decline in the overall VC funding raised in Africa over the year. This downturn comes after a decade of steady growth and the remarkable successes of the previous two years. Startups and scale-ups across Africa have felt the profound repercussions of this shift in the investment landscape. Notably, growth-stage companies have been particularly affected following a period of abundant funding and soaring valuations.
Mobility startup WhereIsMyTransport, based in South Africa, and Kenyan logistics company Sendy recently faced closure due to difficulties in securing additional funding. WhereIsMyTransport had previously attracted $27 million in investments from notable venture capital firms, including Google, SBI Investment, and Toyota Tsusho Corporation. Similarly, Sendy had Toyota among its investors and had received a substantial $20 million Series B round led by Atlantica Ventures in 2020.
Many other growth-stage companies also grappled with the survival challenge, leading them to reduce their operations. This shift was driven by changing investor sentiment, transitioning from focusing on “growth at all costs” to prioritizing profitability. As seasoned entrepreneur Ken Njoroge, co-founder of Cellulant, a payments company, noted, scaling down can sometimes become unavoidable.
“Entrepreneurs who choose to hunker down and focus on improving their unit economics during challenging times can emerge battle-hardened and gain the ability to operate efficiently. This resilience can become a lasting competitive advantage,” Njoroge commented.
Chipper Cash, a fintech company, faced the ongoing cash crunch and further difficulties due to the collapse of FTX and Silicon Valley Bank, the key backers of its $250 million Series C and extension round in 2021, which were expected to provide support during tough times. As a result, Chipper Cash had to implement multiple rounds of layoffs. Cellulant also opted for a more streamlined approach, adopting a “product-led growth strategy” and reducing its workforce by 20%. In addition, Ghanaian health-tech firm mPharma had to let go of 150 employees.
The impact of these challenges extended to B2B e-commerce companies as well. Copia Global decided to exit the Uganda market and had to lay off 700 employees. Twiga made the difficult decision to discontinue its sales and in-house delivery divisions, releasing hundreds of employees. MarketForce also chose to withdraw from all but one of its markets. Nigeria’s Alerzo went through downsizing measures, and companies like Wasoko and MaxAB explored consolidation as a means of survival.”
What’s the cause of this conflict?
Many companies in Africa and numerous others have traditionally sought funding from sources outside the continent. However, only a few Africa-focused funds can provide substantial financial support. Recent data indicates that a significant portion of venture funding in Africa, approximately 77%, is provided by foreign venture capitalists. This heavy reliance on foreign investment is not sustainable for the growth of the African startup ecosystem.
In recent years, some well-funded foreign venture capitalists who had shown interest in the African market have pulled back. They are now hesitant to make new investments in the region and instead redirect their focus towards their primary markets. Furthermore, these foreign investors have become more discerning in their choice of supporting startups, making it increasingly challenging for African enterprises to secure substantial funding.
As Njoroge wisely pointed out, founders in Africa need to be acutely aware of this funding gap. The continent does not have an abundance of available capital, and the most reliable way for businesses to secure funding is by creating value for customers and driving revenue. In such a funding environment, businesses must excel to survive and thrive, even during the challenging funding landscape that persists today and may continue for some time.
What additional funding options exist?
Andreata Muforo, a partner at TLcom, suggests that African companies have various options for raising funds. They can seek investment from private equity funds specializing in late-stage VC companies, explore the possibility of taking on debt, or consider raising bridge financing from their existing investors. Muforo emphasizes that conducting a successful bridge round in these challenging times hinges on having committed African investors dedicated to supporting the ecosystem throughout the year.
Bridge rounds can also serve as a means to attract investors interested in participating but may not be able to lead a funding round. By offering favourable and reasonable terms, founders can entice these investors to join the funding process at an earlier stage,” she explained.
“While founders explore funding options to stay afloat, Marema Ndieng, Africa Lead at 500 Global, emphasizes the crucial role of investor support in enabling portfolio companies to maintain their focus on customers and the path to profitability.
Ndieng suggests that planning and execution should assume market conditions won’t improve. In 2024, the expectation is that portfolio companies in Africa will face continued challenges, and they should adhere to the 2023 strategy of prioritizing profitability and delivering value to customers.
Muforo adds that companies should also develop an effective working capital strategy, which includes emphasizing higher-margin products or services, renegotiating credit terms with debtors and creditors, and optimizing inventory management.”
Litmus test
However, there is a silver lining for the ecosystem despite the challenging funding environment in Africa. This period serves as a crucial test to determine what strategies succeed or fail. Notably, it has exposed the fact that B2B e-commerce companies in the region have struggled with unfavorable unit economics and high expenditure rates. Consequently, this situation has necessitated innovative approaches that ensure higher profit margins, such as optimizing logistics or focusing on high-margin products. It has become evident that massive funding rounds cannot compensate for flawed business models.
Njoroge emphasizes that founders should thoroughly analyze their target markets before taking action. He advises against rushing to secure funding and suggests obtaining minimal funding initially to achieve product-market fit (PMF) and go-to-market fit (GMF). The primary goal is to establish profitability before seeking further investment. He underscores that building a successful company in Africa is a gradual process, often extending beyond the typical timeframe of foreign funds.
“This process unfolds with a gentle and measured pace, distinct from the shorter timeframes observed in more established ecosystems,” Njoroge remarked.
Expanding across multiple countries is necessary to build businesses in Africa and create a substantial market. This, in turn, calls for flexible and adaptable business models.
“In Africa, the journey of discovering product-market fit and go-to-market fit tends to be more protracted compared to the United States. The establishment of customer trust also requires a longer timeline. Developing a deep and diverse pool of talent takes time due to the youthful nature of the ecosystem,” he explained.
Moreover, African nations present a wide array of diverse challenges and opportunities. Scaling Successfully involves a keen awareness of specific macroeconomic, operational, social, and cultural factors, as highlighted by Olugbenga Agboola (GB), co-founder and CEO of Flutterwave. “Companies expanding their presence across Africa must always consider the local nuances within their growth strategies,” Agboola emphasized.
A favorable moment.
“The current funding downturn necessitates a reevaluation of business strategies, emphasizing the need for efficiency and a strong focus on fundamental principles. Industry experts suggest that this period presents an opportunity to distinguish resilient businesses from the less robust ones, providing established companies with a favourable environment to prosper. MaryAnne Ochola, the managing director of Endeavor Kenya, emphasizes that surviving businesses face reduced competition for both customers and skilled talent. Additionally, she highlights the importance of building resilience as a founder during these challenging times.
“Operating in a resource-constrained environment compels founders to adopt resourceful approaches, which will ultimately benefit them when market conditions improve,” she remarked.
Furthermore, the return of prudence in the venture capital ecosystem is expected to foster a more sustainable entrepreneurial environment, as forecasted by Muforo. She anticipates that the reduced growth resulting from the funding constraints may lead to fewer exits in 2024.”
Agboola, on the contrary, anticipates a potential slight opening of the IPO window. He envisions a resurgence in funding, primarily fueled by unallocated capital. However, he cautions that this resurgence may not reach the heights witnessed in 2020 and 2021. Njoroge shares a similar outlook, foreseeing increased utilization of African capital. In contrast, Ochola predicts a continued sluggishness in the market for later funding rounds while early-stage funding activity grows.
Exits
Companies’ progress in their growth phase is often linked to their ability to either be acquired or go public. African companies in this stage face a unique challenge; they might become “zombie” companies. This term refers to businesses that generate significant revenue but fail to draw attention to mergers and acquisitions or increase their market value. Africa has fewer exit strategies and prospective buyers for technology startups than global venture capital markets. Despite receiving steady venture capital for over ten years, the African technology sector has witnessed only a few significant acquisitions, such as BioNTech’s acquisition of Instadeep, Stripe’s purchase of Paystack, Network International’s acquisition of DPO Group, and Visa’s acquisition of Fundamo.
When venture capital is limited, and international corporations are not providing support, growth and late-stage African companies might look into various strategic alternatives. These include acquiring their investors, considering mergers, expanding their funding sources through avenues such as venture debt and private equity, or pursuing an Initial Public Offering (IPO).
Flutterwave, the biggest startup in Africa in terms of valuation, has been a significant topic in the news due to its IPO ambitions over the past year while also dealing with various allegations. The path of Flutterwave is being monitored attentively, similar to the earlier focus on Interswitch. As Flutterwave continues to enhance its corporate governance, there’s a growing expectation for it to prove that investments from foreign investors in Africa are justified.
The fintech company backed by Tiger and Avenir has shown its commitment to date. It is enhancing its appeal in the U.S. by securing 13 money transmission licenses for its Send application and recruiting executives from leading global firms like Binance, PayPal, Western Union, and CashApp.
Understanding the Dynamics Between Founders and Investors
The impact of investors in growth-stage companies is immense, as they can significantly influence the direction of a company, such as taking it public or grounding its ambitions. A prime example is 54gene, an African genomics startup that ceased operations last September.
54gene’s failure was due to various factors, including the high salaries of its executives and the capital-heavy nature of its operations. An overlooked factor, however, was the terms of its bridge deal following a $45 million fundraising. This deal resulted in a two-thirds reduction in its valuation, with a 3-4x liquidation preference.
In the current climate of fundraising, terms that were once seldom seen during the venture capital surge are now a frequent occurrence. Yet, cap tables exhibiting lower-than-usual ownership stakes for actively involved founders can influence subsequent financing efforts, potentially requiring reorganization to draw further investment.
In situations of this nature, Muforo effectively illustrates the underlying forces.
Previously, such terms were uncommon in the venture world. When venture capitalists become assertive with their terms, it often indicates that the business has encountered issues with its strategy implementation and capital utilization or that its growth no longer aligns with its previous terms. A well-managed company operating in a lucrative market with substantial growth potential should have various funding options, making it unlikely for a single investor to dominate.
However, the situation in 2021/22 was unusually favourable to founders yet proved unsustainable, as evident now. We observed inflated valuations disconnected from actual company performance, alongside a lack of solid governance frameworks. This approach does not foster a lasting ecosystem, and the consequences are now visible through reduced valuations and instances of poor governance.
Muforo emphasizes that founders in the growth stage need to meticulously research potential investors before involving them. This includes:
- Fully understanding the terms of investment.
- Consulting legal experts.
- Considering an Employee Stock Ownership Plan (ESOP) that is linked to achieving certain milestones.
If the terms are unfavorable, Muforo suggests that these founders should focus on raising just enough capital to reach their upcoming milestones, avoid unnecessary excess funding, and take steps to reduce costs to prolong their financial runway
The accountability is mutual, though. If investors become too lenient towards founders, skimp on due diligence, or do not set up effective corporate governance structures, it could lead to severe consequences for the African tech scene. The case of Dash exemplifies this. This Ghanaian fintech company raised over $50 million but was forced to close due to the founder’s alleged misrepresentation of financial details and mismanagement of funds. These incidents highlight the need for a well-balanced, transparent partnership between African founders and investors to ensure the longevity and health of the technology ecosystem.
