In the third installment of his four-part series for Disrupt Africa (read parts one and two here), Sw7 co-founder Keith Jones analyses what he calls the “Funding Paradox.
We are in an unfunded market, but there is lots of cash around, both locally and offshore, and the disbursers are as frustrated as the entrepreneurs that the money is not flowing. This is what I have called the Funding Paradox. Those of you that remember Catch 22 will relate.
The markets are very liquid at the moment, and appetite to invest in potentially high growth businesses is high. This capital can’t invest in small businesses that are likely to remain small. In developed markets, there is an established and experienced angel community, that have significant amounts of disposable income. There are incubators, accelerators and experienced government organisations that can engage and disburse effectively.
This ecosystem is there to do one thing, effectively disburse a high volume of relatively small amounts of investment capital. In Africa, we are trying to build this ecosystem from the ground up. Disbursing a high number of low value capital investments in a way that makes commercial sense is difficult, and this problem is compounded by the fact that we have a desperate shortage of last mile skills: people that know how to engage with, assess and disburse to early stage tech businesses.
The investors want to invest in the next US$1 billion business, but they play a spread betting game, where they invest in ten businesses and one succeeds. The entrepreneur only has one shot, they have no spread bet and there is no safety net. Thinking big often means burning through all your cash and failing fast. This is where the market is right now. Investors want big thinkers, big thinkers usually can’t get access to Seed or Series A capital.
In the current market, thinking big will be closely associated with failure and if you do raise capital, the pressure this places on the initial investor is significant, as once they have invested, the pressure on them to fund subsequent rounds to avoid watching their initial investment evaporate is high. In a dysfunctional funding ecosystem, the first funder is obliged to do Seed, A and B, which gives them a high risk position in one investment, when their job is to spread bet. In spite of popular perception, entrepreneurs are risk averse, their job is to mitigate, not embrace, risk. The entrepreneurs are being trained by the market not to think big, the market is looking for big thinkers.
If you take the Missing Middle into account, to succeed you should look at partnering with a large corporate to gain market access. If you partner, you become slow growth, as your growth is constrained by corporate procurement and partnering cycles, which makes you uninvestable to high growth investors. The local VC markets do not have the appetite or experience to speculate on high-risk opportunities in the tech sector and tend to focus on larger deals only.
The African markets are driven by the old school VCs, where they need an Income Statement to engage. This means over three years of trading history, and it will be a bootstrapped business that has grown organically through self-funding. Bootstrapped businesses are, by definition, cash strapped, and not usually growing in multiples, but in strong percentages. If you are not growing in multiples, you become a bad bet for high-growth investors and enter the PE and profit warranty markets, where the spreadsheet jockeys rule. To be high growth, the magic is in the mystery, where this thing could be huge. If there is still mystery in your growth, you can sell a vision to the investor of a return in multiples.
It looks like there are the beginnings of an angel market in Africa, where a few committed individuals are doing their best to initiate the market. It is not enough to feed the growth we need. Many of the angels don’t know how to engage with the tech sector, and, rightly, do not want to be taken for a ride.
What defines our funding market in Africa is almost no Seed and Series A capital, no last mile skills to disburse effectively, and a cautious and inexperienced angel market. There are a number of government initiatives and international funders supporting the sector, and there is no doubt the matching vehicles that launched Silicon Valley, Israel and Canada will be hugely beneficial in our technology markets.
These governmental and international bodies are constrained by their lack of understanding of the sector, which is compounded by the shortage of last mile skills. This combination is likely to invalidate much of their contribution. Their contribution tends to be focused on foundational skills and physical infrastructure, but there is no evidence to suggest this will contribute to the ecosystem and drive the markets in a meaningful way. This is not meant to diminish their contribution, we are all in the process of trying to figure this thing out together and we don’t profess to have any answers yet either.
Funding is likely to remain a constraint, but this should reduce as the last mile skills pool builds, the powers that be figure out how to access the market and the Missing Middle becomes more engaged. There are one billion people in Africa, the market is connecting and adapting at a very high rate. Our population is forecast to grow to four billion 2050, so any traction and footprint created now is likely to show significant returns in the future.
The African market is likely to remain a bootstrapped market, the demand for support will outstrip supply. The rate of innovation will outstrip the ability of the larger organisations to adapt to meet the need, which will increase the opportunities we have. The funding and support mechanisms are on the increase and we are going to see an increasing number of rockstars, but for most of the entrepreneurs out there, accept the fact that you are largely on your own and unsupported, and likely to remain so.
