Innovation Funding in Africa: Are VCs & Impact Investors Taking Enough Risks?

There are an increasing number of new Venture Capital firms (VCs) present on the continent in the last few years such as Fanisi Capital that operate in East Africa and the recent Adlevo that focuses on South Africa and West Africa. Then there are a new crop of investors known as impact investors which include Acumen Fund and Omidyar network. This is great for Africa as most people believe that Africa needs more investment vs AID, particularly in light of less available foreign AID from western countries and increasing influence from China. I wanted to examine who is funding entrepreneurship innovation in Africa in this, my very first official post as an author on Afrinnovator. Previous posts I wrote as a guest blogger can be found here and here. You can follow me on twitter.

Impact Investors are better than AID systems when it comes to funding innovations in the social sector 
Impact investors can be viewed as a new form of “assistance” that empowers entrepreneurs to find innovative solutions to social problems from small farmer agricultural assistance, healthcare to education. They increasingly rely on technology as key tools to achieve scalable solutions. They have funded some exciting companies in these areas in recent years. Bridge International Academies is a $4/month low cost franchise school system in Kenya that relies on ever popular mobile money service M-PESA as an innovative way to ensure funds flow efficiently from parents to schools to teachers. Sproxil is a SMS drug authentication service that combats counterfeit medicines in Africa. Impact investors are welcome because they supplement what were traditionally an AID system that works with NGOs and Governments with a “market driven” system that provides investment capital to entrepreneurs. I will leave readers to judge which is a better way for Africa to innovate its way out of its social problems.
The issue I have with impact investors is the often unclear way to which they assess investments, sometimes very nebulous measures such as “lives impacted”, but they can often be more complicated – the entrepreneur by very definition has to become a “social entrepreneur”, not a bad thing if that’s the kind of venture one wants to build – however impact investors sometimes overlook the indirect social impact benefits of enabling a pure for profit business which inc. wealth and job creation. Yes, jobs that allow africans to contribute to the tax base, be able to feed their families, pay medical bills and send their children to school.
The best thing about impact investors is their patience – they are trading off financial returns for “impact”, their patience in investing is welcome on the continent where often more time is needed for a business to scale out vs other markets. They provide critical dollar investments where other investors can enjoy safer returns in other growth markets such as Brazil, China, Russia and India.

VCs in Africa are not taking enough risk

Venture Capital in Africa on the other hand has tended to fund infrastructure and later stage companies. Fund sizes tend to be around $50-100M, and given the limited board seats venture partners can sit on and hence deals they can make in a given year, minimum investment tend to be $1M. Many of these VC funds tend to profess that they enable funding of the “missing middle” – what middle are they talking about? For certain sectors such as energy and traditional healthcare this may be the case, but when it comes to web and mobile startups, this middle may be the equivalent of “later stage funding” – they act more like private equity (PE) shops than true VCs.

There is a very handy list compiled by the South Africa Chamber of Commerce in America (SACCA) that profiles over 200 funds focusing on the missing middle.

Gap in Early Stage Innovation Investment in Africa

This still leaves a significant gap for early stage investing in web and mobile startups that constrains potential innovation. We all know the numerous trends in mobile in Africa – it is arguably the most powerful infrastructure ever set up to enable innovation and change at almost every single sector or discipline, not just in Africa but globally. VCs are meant to enable this innovation by taking risks and to drive high returns to investors whilst helping to change the world. It is a “home run” business not a “batting average” one, this means in a given investment portfolio of innovative startups, only one huge success can pay for 9 other failed companies. VCs in Africa don’t seem to be taking this approach – often funding companies already doing well and generating cash to which they can put their capital to work.

The pieces that enable innovation are changing – cheaper, better, faster. But talent remains the biggest constraint

The cost of launching internet startups has dropped 90% in the last 10 years (thanks to open source, web frameworks and cloud computing), and the even bigger drop in cost of communicating globally (thanks to VOIP, sms, facebook, linkedin) – it is now possible to set up a venture and adopt lean startup methodologies that can get companies to prove a business for much cheaper than the $1M minimum typical VC investment in Africa. In fact, I would now argue that capital is no longer the differentiator that ensures success at the earliest stage – rather your team and advisors that mentor you and ensure you don’t repeat the same mistakes are most critical. The problem in Africa is that the angel investors who are able to advise such companies are limited or have yet to get into angel investing. In Silicon Valley they are plentiful, entrepreneurs who make it big often give back as angel investors – it is almost expected and is the social norm and a critical part of the ecosystem. Angel investors are actually a sort of impact investor – they take huge risks and are often giving their very valuable time and domain expertise in conjuction with their capital – their help in the very early stages of a company often outweighs the advice any grey-haired VC can ever provide on the latest technological trends, often they can sit right beside you and code or once pioneered a marketing technique in their last company they can apply to your startup so you don’t need a huge marketing budget to get early customers. They act as key catalyst for knowledge transfer and raise the probability of a startup’s success.

VCs often complain (and if not they should) that “there is not enough qualified entrepreneurs to fund” because what they care and focus on is deal flow and building out a bigger team and business. Angel Investors however, typically take someone with potential and mould them into an “investment grade/VC backable” entrepreneur by adding their mentoring/education to get their product or service of the ground. When the two are intwined in an ecosystem – they become very powerful agents of change – if one is missing, innovation is often constrained.

Angel Investment + Incubation = Form of Impact Investment in Educating Entrepreneurs

Where does this leave the state of African VC/Impact backed internet startups? Unfortunately, I would argue not very far – these investors need to take more risks or a new crop of angel investors with tech experience (preferably local) to advice startups needs to emerge that then bridge the gap to VCs, otherwise the innovation potential in web and mobile startups in Africa would remain limited. It is ok to have failed startups (especially at relatively low amounts of seed capital) if entrepreneurs learn – next time they may well hit a home run. Entrepreneur learning IS a “social impact” even if they fail. Are there any impact investors out there who include the “entrepreneur learning” metric in their impact investment programe evaluation? One piece of the puzzle is being built out with the emergence of various incubators across the continent and is encouraging that many of them as sharing best practices and networking amongst each other across the continent to make it an increasingly smaller place.
I recently visited who have set up a training school and incubator “Meltwater Entrepreneurial School of Technology” (MEST) in Accra, Ghana that fuses technical software development with sort of entrepreneurial MBA. Graduates are expected to work on a startup idea upon graduation that feeds into the incubator. Funding from $20-200k is provided for promising ideas. What I like about MEST is that its backed by a successful tech company with resources and talent globally they can leverage to provide the best assistance to fulfill their mission. If a graduate decides to take a full time corporate job, they can still come back later and join the incubator and secure funding once they have an idea they’d like to pursue. This is an example of a potential future educational system to encourage and combine the elements I mention here to enable more innovative talented entrepreneurs. At an even earlier stage, the African Leadership Academy is playing a key role here in South Africa – we need more of such efforts that help train talent at home which can train leaders and entrepreneurs – such models are inherently time intensive and patience for the long term is required to see the results.

Back to AID. It is fascinating to see some of these interesting developments (innovation and entrepreneurial driven change) feeding back into to foreign Aid policy. A new US program called Global Innovation through Science & Technology (GIST) that was a result of Obama’s strategy in Muslim countries around the world to engage in entrepreneurship as a source of economic growth, many of which are in Africa.