Nigerian venture capital poses tougher funding questions to startups

Over the past half-decade, the boom in the African tech ecosystem has produced some pretty impressive valuations, with unicorns like Nigeria’s Flutterwave and Senegal’s wave raising hundreds of millions of dollars. Even some smaller, unproven startups have raised millions in a fairly short time. In the first quarter of this year, African startups raised $1.8 billion, more than they were raised in all of 2019, according to analysis by Africa: The Big Deato. However, few people have even blinked about how to arrive at these astronomical numbers. It was a prime example of “momentum” investing, as one veteran venture capital partner told me last week: As long as money keeps flowing into the market, other investors will follow, more convinced of the same trend than any fundamentalist or founder talent.

The accepted premise went like this: Africa is a huge market opportunity with 1.2 billion people and a growing middle class, coupled with an underdeveloped physical and digital infrastructure. Informal economies everywhere were ready for online introduction by digital businesses. If you make the right bet in such a young ecosystem, you can hope to make a huge return. The idea of ​​”Africa Rise” has seen investors flock to the market, many of whom have little knowledge or experience in sub-Saharan Africa.

The reality is a little more complicated. The addressable market – the actual number of customers that can be reached – is well below 1.2 billion. Given the potential of an app-based idea, for example, an investor might see 500 million phone subscribers, but that doesn’t mean that all phones are smartphones, and it doesn’t mean that all of those phone subscribers can buy enough internet data to run a tailored app. For a seamless “always connected” lifestyle. In other words, investors still have to know the true size of the opportunity – the “serviceable market” – and, within that, how much they can grab.

This disparity is becoming more pronounced as funding begins to slow significantly in the West, and most African-based investors and founders – who are well aware that much of the funding has originated from Silicon Valley – expect financing to slow here as well. This means that more specific questions have already been asked of founders, according to two venture capitalists and one founder I spoke with in the past two weeks.

The root of these misconceptions is the lack of widely available consumer and business data, which allows investors to gamble on the best-case scenario in a “high market” but less so when investors tighten their belts. The data vacuum affects more than just the tech sector, but the effects there are more pronounced due to the amount of bets being made.

Ironically, Jake Cusack, co-founder of investment advisory firm CrossBoundary, calls it a “first mover defect.” Without a range of reliable information and a few other technology companies with which investors can compare, the inability to scale can encourage inflated prices. It’s not just about the initial potential for market size, Cusack said – an investor needs to identify pockets of willingness and ability to pay for new services.

pay it Yannick Lefang founded his consumer market research company Kasi Insight in 2013. “The main problem we’re trying to solve is the disconnect between the continent’s potential and its reality,” Lefang told me. “This really summed up the lack of reliable data.”

Kasi Insight has spent the past few years building consumer panels, and now it polls between 500 and 1,000 people in 20 African countries each week, to deliver some of the key findings a tech or venture capital founder might need to understand their market opportunities.

According to Lefang, while companies such as manufacturers of traditional fast-moving consumer goods (FMCG) or makers of luxury goods often subscribe to his company’s services, few tech companies or investors ever do. “Everyone knows there is a lack of data, but that doesn’t mean they will buy your data,” he said.

It was a similar case for Fraym, a market research firm that uses a combination of household survey data and geospatial satellite data, analyzed by machine learning software, to understand consumer markets in Africa and other developing regions. Bobby Pittman, president of Fraym and co-founder of Kupanda Capital, said foundations, NGOs and government agencies, rather than technology companies, have dominated their client base. “As investors, we built Fraym because we wanted to understand the market for ourselves — but not many other investors do,” Pittman said.

“The project deals were done so quickly, with so much foam, that there wasn’t enough time to do the due diligence.”

For the most part, any concerns about a lack of data have hardly slowed African founders or their backers, as venture investment has taken a hit. $4.4 billion Last year, it more than tripled the pre-pandemic levels of 2019.

Not all investors are indifferent to minimal due diligence. “Investing here is a lot of art,” said Ike Echeruo, managing partner of the Constant Ventures Fund, which this week announced the launch of a $100 million fund to support African start-ups. “You can see the lack of data as a flaw, but this is inherent in all informal systems,” he added. “There are other things you can see…by anecdotal sampling of people and extrapolating carefully.”

He said his firm’s analysts and partners spend time in the market talking to business and consumers about the local challenges they face. But Echeruo also agreed that high valuations have become an issue in recent months, with little evidence to support expectations. “I’ve seen a lot of formations come up, and in many cases, it’s not clear to me what is driving this assessment.”

Behind the rush was also that simple push to invest momentum. In the so-called “hot” market, where investors vie to fund the next coveted startup or admired founder, there is often a rush to outsmart rival venture capital firms in order to “enter the cap table,” investors said. I talked to. This means thin due diligence. “The project deals were done so quickly, with so much foam, that there wasn’t enough time to do the work,” said Frameman’s Pittman. “We have major startups that reached out to us prior to the funding round, but even before we could find out what was going on, the deal was already closed.”

Lefang echoed the same, saying that many international venture investors operating in Africa are not incentivized to conduct deep market research, as they may not be in it for the long term.

Ngozi Dozie, who co-founded consumer loan company fintech Carbon in Nigeria in 2015, said he had to independently gather data from government agencies, established banks and institutions like the World Bank and McKinsey, to better appreciate the true market potential of his startup.

After “triangulating” data from industry bodies, including the Nigerian Banks Settlement System, EFInA (a non-profit organization for financial inclusion), and mobile industry data, he estimates that the total market opportunity for his business will be around 30 million users, in a country with a number of Its population is 200 million. But, realistically, he estimates the chance of a service to be roughly 10% – 20% of that. Dozzi said he believes fintech startups, traditional banks and others are pursuing a very similar market base. “We’re all squabbling over the same 6 million customers, in my opinion,” Dozzi said. “If I was generous, I’d say 10 million.”

Most of the investment action over the past year has been in the fintech sector, as young companies race to bypass aging, regulated, and under-resourced infrastructure. This segment has produced the continent’s most famous unicorns, such as Flutterwave, Chipper Cash, and Wave. In the past year, fintech companies—whose sub-sectors include payments, remittances, new banking, consumer loans and financial infrastructure—acquired 53% of the total funding.

In recent months, this rush has come along with mounting concerns and naysayers in recent months questioning whether aggregate African markets actually have enough financial services consumers to justify the number of fintech startups or the high valuations assigned to some of these companies. And it’s not likely to cool completely anytime soon. Echeruo of Constant Ventures said his chest would definitely look into this space. “Fintech in Africa is still underutilized, but the opportunity is looking for real problems to solve, such as the lack of credit – which is a massive problem.”

If financing slows, as expected, as some founders fear, there will be a natural jolt to the entire ecosystem, and calls for better investor due diligence will grow. Those who understand the realistic size of market opportunities can be well off if they really have cash on hand and a good cost structure: “It’s ultimately a zero-sum game: if you win, someone loses,” Dozzi said.